Name: Ernatalia Sari, S.

Division: SMACC

How to Separate Your Business and Personal Finances

Keeping Your Business and Personal Finances,

Certain things just don’t mix well - like a good scotch and soda, like Rajnikant and Laws of Physics, like
Rahul Gandhi and politics and like your personal finances and your business’s. Keeping these things
separate not only helps you reduce problems, it also greatly simplifies things and makes it easier to
manage your finances.

When you first started your business, like many entrepreneurs, you may have used your personal assets
for startup capital, or may have secured a business loan based on personal assets. As your business
grows, creating a clear boundary between your personal and business finances is crucial to staying on
the right side of the law.

Even if you’re just starting out, it’s essential to split up these two parts of your money life. Treat your
business, no matter big or small, like a viable entity.

Don’t know where to start with separating out your personal and business finances? Let’s start with
expenses. An expense can be defined as money spent or cost incurred in an organization’s efforts to
generate revenue which is also known as the cost of doing business. However, there are expenses that
are carried for satisfying our wants and needs that are of personal nature and does not result in any
incremental revenue.

Therefore, separation of both these expenses is a very necessary exercise. Some of the reasons why
this exercise should be carried out:

1) The cost of doing business

As a business person you would always want to ascertain your cost of doing business and to
analyze various expenditures carried out during the year. There might be some expenses which
you might want to control or avoid altogether, but the same cannot be ascertained if personal
expenses are also clubbed with them. There might be even cases where a major portion of a
particular expenditure is of personal nature but is clubbed and claimed as an expense in the
books of business, hence increasing the cost of doing business unnecessarily. For example, if
you travel to your office by your car and also use the same car for personal purposes then the
vehicle maintenance and fuel expenses should be allocated between personal and business
uses appropriately.

2) Statutory Compliances
Among numerous laws, Companies Act and Income Tax Act particularly require ‘persons’ to
separately account for personal as well as business expenses. Income Tax act requires adding
back any personal expenses if deducted while ascertaining book profits to arrive at taxable
 profits as the same. Hence, separation is necessary as well as mandatory to avoid non-
compliance with laws in force.
3) Treatment Of Assets
Most of the times, personal assets are added to the block of business assets and depreciation
is claimed which ultimately leads to a reduction of tax liability. This is a classic case of tax
evasion and many a times laymen don’t even know that they are a part of such activity due to
unawareness and improper guidance by their income tax professional. Hence, to avoid
unwanted and unexpected repercussions one should maintain separate books of accounts for
personal as well as business expenses. For example, you have bought a video game console as
a gift to your son and maintained the same as a business asset as you do not maintain any
separate personal account. Depreciation on such machine will lead to understating of income
which ultimately results in lower taxes. Same goes with all the sorts of personal assets which
you are carrying in your business balance sheet.

4) Know your assets and liabilities and ratios

Intertwined books of accounts will not give a proper and fair view of your assets and more
importantly your liabilities. This may even lead to chaos and result in delayed and even non-
payment of liabilities which require immediate attention. For example, you have deposited a
huge amount in a certain portfolio to be used in future only for personal purposes. Such
investments do not add any value to the business and mixing them with your business
investment portfolios may give you a wrong picture of your business net worth and assets
available for business.

5) Claim on assets
Separating personal assets from business assets is a must. For example, you have taken credit
by mortgaging your business assets, then if things go south then only your business assets
shall be seized and the lending company will not have any right to seize your personal assets.
However, non-separation may result in seizing of personal assets as well.

How to separate your personal and business finances?

a. Make it official
Consider establishing a partnership firm, limited liability company or a private entity for your
business. You can refer to Ministry Of Corporate Affairs’s website or sit down with your advisors
– like CAs, lawyers, CPAs or financial planners and determine what entity makes the most sense,
how this business will impact your taxes and financial planning. These business entities will also
give your personal finances a new level of liability protection, which could come in very handy
of your business is ever sued.

b. Classification of finances
Keeping separate records of accounts, one for personal and another for business nature of
finances is one of the oldest methods. However, maintaining two separate books of accounts
can be cumbersome and are prone to errors. Hence, proper classification of heads of accounts
is a must for keeping personal and business expenses and incomes separate. For example, you
 have purchased two desktop computers of which one is to be used at home. Then in such case,
the cost of that one computer to be used at home should form part of the amount drawn out
of business for personal purposes and not of business block of assets.

c. Open separate expense accounts

If you are paying for some services or products which are used for your business as well your
personal needs, then you must keep in mind to open separate expense accounts due to the
similarity of expenses. For example, UBER cab booking application provides you the choice to
select whether a particular trip is for personal or business purpose. Before riding, you can select
the appropriate head and avoid either overcharging or undercharging the workplace with cab
fares.

d. Separate bank accounts and credit cards

Separate bank accounts and plastic currency such as debit cards and credit cards enable you
to maintain a tally of such finances separately, and there will be no need to group and analyze
each and every expense/income from the bank statements, as the process is lengthy and
cumbersome. For example, open a separate bank account and a credit/debit card for that
account and it should be solely used for business expenses. Same goes with your personal
account and plastic cards, that they should not be used for carrying out business expenses.

e. Pay Yourself a Salary

One should fix a particular amount to be withdrawn every month from the business as personal
drawings for carrying out household expenditure. Open another separate personal account
meant only for the purposes of carrying out expenses of personal nature. By adopting this
practice, the amount withdrawn as drawings will not affect the profit and loss statement of the
business and separation of accounts and bank statements will ultimately provide clarity and
proper maintenance.

f. Separate loan accounts

Imagine, you want to avail home loan from a bank in which you even have your business
account with, and the bank official offers you to adjust interest periodically from your business
account. This looks good as you will not be required to keep track of your periodical payments
and the bank will do the same for you. However, a house is a personal asset and interest on
such assets if adjusted from the business account will ultimately end up forming part of
business interest expenses. Therefore, one should adjust the same from the separate drawings
account in the bank and linking with business account shall be avoided.

g. Hire a professional accountant

If you want to manage finances, you ought to hire a professional accountant. A professional
accountant will guide you through classification of expenses, accounting treatment, taxation
impacts of transactions, etc. Hence, hiring a professional accountant will enable you to keep
your books clean and clear.
 h. Implement a dedicated accounting system
If you’re comfortable with a Do-It-Yourself approach, there are a number of tools available for
tracking your business income and expenses. For example, ProfitBooks allows you to create
invoices, record expenses, track inventory and manage taxes. Its super simple to use and you
don’t need any accounting knowledge to operate it.

Source : http://www.profitbooks.net/how-to-separate-your-business-and-personal-finances/