There is a good reason why you have to keep your business and personal finances separate as a small business owner. NOT doing so is one of the main reasons South African small businesses fail at such an alarming rate.
Before we delve into the why and how of separating your business and personal finances, it’s important to acknowledge that this is often easier said than done. It’s not that the actual steps are difficult (they are not, as we’ll see shortly), but the psychological component is tougher to overcome, especially if you are the only person in the business.
Quite simply, you cannot separate the entrepreneur from the home owner or parent or friend dealing with personal difficulties at the end of the working day. Even if you have all the systems in place to draw a line between your business and personal finances, it’s like being entrusted with the key to the sweets cupboard. When you are tempted to overstep, and you will be at some point, there’s no-one stopping you from dipping your hand in the cookie jar. At times like these, it’s vital that you remember the reasons for drawing a clear line between your business and personal finances.
Why should you separate your business and personal finances?
Here are 5 reasons why it’s a good idea to keep your business and personal finances separate.
1. Knowing how much it costs to run your business
If you are serious about your business, surely you want to know how much it costs to run it? If you muddle your expenses, for example your office and home groceries, it becomes much more difficult to keep track of your business expenses. It creates the danger of either vastly overstating or understating the costs – neither of which are good. Also, you’ll create a headache for yourself come accounting time.
2. Planning for business growth
Related to having a clear idea of your business costs, is possible plans for expanding your business. Whether you want to appoint an employee or launch a new product line, you will need to know if the business can afford it. If the lines between business and personal finances are blurred, you will be unable to accurately determine whether the business can support the expansion in the long run.
Furthermore, if you want to get funding to grow your business, you will have to show possible investors a detailed financial plan, including a breakdown of all business expenses. It’s impossible to do this if you do not know what the business expenses actually are.
3. Establishing a credit record
One of the ways to fund business growth is by obtaining a business loan. To qualify for a loan you need a credit record for your business. The best way to do this is to have a dedicated business account where you can build up a credit history. You are more likely to get a loan if the bank is able to identify a clear pattern in the finances of the business.
4. Staying on the taxman’s good side
You are allowed to deduct certain business expenses from your income for tax purposes. For example, as a sole proprietor you would be able to claim all groceries purchased for your business. The key is that the expense should have been incurred in the production of income. Personal groceries can therefore not be claimed.
If you do not keep your business and personal finances separate, you will not be able to optimise your tax return by claiming business expenses. Because SARS is wise to small businesses not always keeping proper records, they are on the lookout for returns that look fishy. Should you claim business expenses that are blurred with personal expenses, you are increasing your chances of being audited by SARS. This will create problems for you if you subsequently do not have the documentation to back up your claims.
5. Protecting your personal assets from business claims
Different business entities have different legal rights and obligations. There are many factors to consider when choosing how you want to set up your own business, including the number of employees, tax structures and your strategic plan. One of the most important considerations is the risk factor involved in your line of business.
Setting up a private company creates a legal separation between your business and personal assets. Creditors will, as a rule, not be able to lay a claim against your personal assets if your business assets are insufficient to cover their claims. This distinguishes a company from a sole proprietor and partnership, where your personal assets are also exposed to claims associated with your business, even if these assets are not related to the business.
The type of entity best suited to your situation is highly dependent on the business. It is therefore advisable to consult with an expert when selecting a business entity.
How do you separate business and personal finances?
Now that we’ve established the reasons for separating your business and personal finances, let’s consider how you should go about doing so. None of these 5 steps are difficult to achieve, so nothing is stopping you from doing so now!
1. Making it legal
As I’ve mentioned above, the considerations for the type of business entity you should establish are numerous and highly dependent on your own situation. If you do decide to register a company with CIPC, you can do so online. The process is fairly straightforward and CIPC has guidelines available on how to do it. You can also register a company with CIPC through FNB when opening a business account, or you can ask a business consultant to do it for you, usually at an administrative fee.
2. Opening a business banking account
If you do only one thing in your quest to separate business and personal finances, open a business banking account. It will allow you to manage the business finances better by clearly and easily identifying income and expenses. It’s important to note that you do not have to register as a company to open a business account, so don’t let the legal status of your business deter you.
All the major South African banks offer business accounts at affordable rates. As with personal accounts, you get different packages, so read the fine print to make sure you choose the option best suited to your needs. For example, the account fee for FNB’s pay-as-you-use option is only R80 a month, but you pay R9,64 for third party payments and R3,64 for debit card purchases. The usage can therefore quickly exceed the R252 monthly fee for the smaller of their two single fee packages.
The added benefit of having a business account is that it will make you look more professional and serious about your business.
3. Separating business and personal expenses
As far as possible, pay for your business and personal expenses separately. When you buy groceries, ask the cashier to ring up two separate transactions and pay one with your business card and the other with your personal card.
Some expenses are more difficult to separate, e.g. your cellphone and car. Keep a logbook for your car in which you note all your business travels – you will need this anyway for tax purposes. If you really cannot separate expenses like your phone or internet, you will have to make an informed guess. Be realistic though and always try to have some documentation to back it up.
4. Paying yourself a salary
You should view your business as any other employer. If you are a salaried employee, you have to make do with what you have. If that means cutting back in the last week of the month, you do so. Get into the habit of paying yourself a fixed salary once a month by transferring money from your business to your personal account, and then manage your household finances from your personal account only. If you want the business to succeed, it is imperative that you do not view it as your personal piggy bank.
5. Creating a budget for your personal finances
By now you know why it is vital to separate your business and personal finances, and also how you can do so in practical terms. But all of this is pointless if you do not have a handle on your personal finances. You may be an expert at managing the business finances, but if your personal finances are a mess they will infringe on the business finances sooner or later.
In the previous point I said you have to get into the habit of paying yourself a salary. To give your business its best chance of success, this salary should be fixed in advance so the business can budget for the months ahead. From your personal financial position, how will you know what that salary should be if you do not know what your personal expenses are? And from the business side, how will you know whether the salary you have included in the forecast for the year is appropriate?
The reality is that you can’t answer these questions if your personal finances are out of control. As a result, you will constantly withdraw money from the business for personal use. This is one of the surest ways to set up the business for failure as few small businesses can withstand such constant cash flow shocks. Don’t let your hard work in the business go to waste because you are neglecting your personal finances.
Get in touch if you need assistance to separate your business and personal finances, or if you’d like advice on doing things better than you currently are.