Most small business owners encounter financial hiccups at one point or another; it goes hand in hand with being an entrepreneur. While it may be tempting to dip into your personal savings to see you through, doing so could lead to unwanted financial consequences. Still, 48% of business owners used their personal savings to keep their operations running through the COVID-19 pandemic, according to a Bank of America report.
But before you mix your personal and business finances, make sure you understand the following risks.
5 hazards of using personal savings for business expenses
1. There could be tax consequences
The sooner you open a separate business bank account, the better. The idea is to untangle your personal and business finances as early as possible. When your business encounters a surprise expense, you can draw on your business account to cover it. Reaching for your personal savings could create some tax headaches.
Accuracy is key when filing your business tax return. If you’ve used personal funds or loans to pay for business expenses, you’ll have to sort through your transaction history very closely to determine which withdrawals were made for business and which ones covered personal expenses. If not, you could end up miscalculating your taxes.
One other thing: qualified business expenses are tax-deductible, which means they reduce your taxable income. Accidentally writing off personal expenses could land you in hot water with the IRS. On the other end of the spectrum, paying business-related bills with personal savings could cause you to overlook tax-deductible business expenses.
2. It might open you up to liability issues
Structuring your business as a corporation or LLC has its legal benefits. In the eyes of the law, your business is seen as separate from you as an individual. If someone sues your corporation, for example, your personal assets are protected. However, things can get murky if you’ve been mixing personal and business finances. According to LegalZoom, it might appear that you and your business aren’t separate after all, which could open you up to personal liability issues.
If you have an LLC or corporation, your business’s creditors cannot seek payment from your personal assets — unless they “pierce the veil” of limited liability. This could happen if a creditor sues you personally and makes a strong enough case against you. When all is said and done, it’s always best to keep your personal finances out of your business (and vice versa).
3. It depletes your savings
Personal savings are there for a reason. Most experts recommend keeping three to six months’ worth of expenses in a liquid emergency fund. If you encounter a financial surprise, you’ll have that money there to support you. This can include everything from job loss to a medical emergency to an unexpected home or car repair. Think of it as a financial safety net.
If you’re dipping into this pot to cover business expenses, you could be robbing your future self of financial security. The next time you need this emergency fund, the balance could be lower than you need it to be. One important note: if business revenue slows down and your take-home pay temporarily shrinks, there’s nothing wrong with using your emergency fund to cover personal bills and other necessary spending — that’s what it’s there for. You want to avoid using your emergency fund to cover business-related expenses.
4. It can make accounting tricky
Nothing is more important to business accounting than having clean, organized records. That means:
- Hanging on to all receipts for business expenses
- Keeping a detailed record of all business expenditures and outstanding bills
- Maintaining an accurate record of business income, including unpaid invoices
Using personal funds to cover business expenses can complicate your recordkeeping. Beyond creating confusion internally, it could also spell trouble if you’re ever audited by the IRS. In that event, you’ll need to produce accurate records to prove that your business tax return aligns with your actual bookkeeping. If everything’s all mixed up, there’s a higher chance of encountering issues.
5. Your business may appear illegitimate
Paying business expenses with your personal checkbook or credit card doesn’t exactly signal professionalism. Similarly, it’s bad form to request that clients pay you personally for your services. Establishing a separate business bank account can solve both problems. You can pay for business-related bills out of this account and request that your customers remit payment here too. Consider it a central hub for your business’s income and expenses.
How to avoid commingling your finances
Create separate business and personal accounts
As we’ve stressed, this is one of the most important steps you can take as a small business owner. It goes beyond just opening business checking and savings accounts. You’ll also want to think about your business’s credit needs. If you’re in need of ongoing capital, a business credit card could be a great option. You’ll likely need to provide information such as your:
- Business structure
- Employer identification number (EIN)
- Annual business revenue
- Estimated monthly spending
- Length in business
- Number of employees
- Personal information like your Social Security number
Your personal credit will come into play too. That’s because many business credit cards require a personal guarantee. Credit cards aside, building your business’s savings account can also make you less dependent on personal savings.
Structure your business appropriately
The legal structure of your business is equally important. After choosing one, you can then register your small business and start operating. Your business entity will shape your tax obligations as well as your ownership and liability details. Again, certain business structures protect you in terms of personal liability.
If you’re a one-person show running a sole proprietorship, for example, your business assets are completely entwined with your personal assets. That means you could be held personally responsible for business debts. Opting for an LLC or other business structure can limit your personal liability — and keep your business and personal finances separate.
Consider a bookkeeper
Bookkeeping is an essential part of running a business. It involves tracking your business’s daily financial transactions and maintaining accurate records. It’s usually the bookkeeper who reconciles accounts payable and receivable, plans for taxes, updates financial reports, handles invoicing, and more.
Some business owners are comfortable using bookkeeping software that makes these things easier. Others may benefit from hiring an in-house bookkeeper who can fully take these tasks off their shoulders. If your budget is tight, you might consider partnering with a freelance or part-time bookkeeper to work on a schedule that feels right for your business. Either way, the goal is to create a system that keeps your financial records clear and tidy.
When all is said and done, it’s always wise to keep your personal and business finances separate from one another. Using your personal savings to cover business expenses could muddle your records — and lead to potential tax and liability issues.