Mixing personal and business expenses is one of the most common bookkeeping mistakes made by small business owners. This is formally known as commingling funds and causes many tax and bookkeeping headaches that hold your business back from success.
To be fair, it’s easy to mix personal and business expenses throughout a busy day.
Let’s say you stopped at an office supply store to grab printer ink for your office and spotted a new book you’ve been wanting to read. If you use your business credit card to pay for both purchases, you end up with mixed transactions. Combining personal and business expense transactions like this makes it hard to correctly determine profitability and costs on financial reports.
Other common examples of costs being incorrectly accounted for include:
- Using the same bank account to pay for personal and business costs;
- Moving money between business and personal accounts without documenting the transfer; and
- Paying for personal expenses (like a meal) with a business credit card.
Problems that come from mixing personal and business transactions
Even though it can be inconvenient to keep purchases separate, author Julia Quinn was right when she observed, “There is never anything to be gained by taking the easy road.” Taking time to do things right, even if it’s inconvenient, will help you avoid many tax and bookkeeping problems later on, such as:
- Audit risks: If you claim personal expenditures as business expenses, you might face serious risks during tax audits. Auditors can deny deductions, impose penalties, and in severe cases, legal action can be taken.
- Incorrect tax reports: Personal expenses inadvertently reported as business expenses can lead to underpayment of taxes, which could potentially attract scrutiny from tax authorities.
- Misrepresentation of profitability: With a mixture of personal and business expenses, your company’s profitability may be inaccurately represented, which can hinder your understanding of your business’s financial health.
- Time-consuming reconciliations: Sorting out business expenses from personal ones can be a time-consuming process, especially if you’re trying to backtrack several months of financial activity. This time could be better spent focusing on your business growth.
- Impaired creditworthiness: If you’re seeking a loan, lenders may question your financial responsibility if they find evidence of commingling. This could impact your creditworthiness and your ability to secure funding.
- Inaccurate financial reports: Investors, creditors, and other stakeholders rely on accurate financial statements. Commingling can lead to inaccurate reporting, damaging the trust and confidence stakeholders have in your business.
- Entity risk: While sole proprietors can avoid commingling simply by separating bank accounts, mixed funds become more of an issue with LLCs, S corporations, and C corporations since it compromises the liability protection offered by these entities.
Keep your personal and business accounting separate
There are several ways to keep your company’s accounting organized and maintain accurate financial data, including the following:
- Keep separate bank accounts: Using a dedicated business account will help streamline your finances and make it easier to track business transactions and expenses.
- Hire professional bookkeepers and accountants: A professional bookkeeper or accountant like those at MBS Accountancy can help you maintain clean and organized financial records so your financial reports are accurate and reliable.
- Use separate credit cards: Use a dedicated business credit card for all business-related purchases. This can help you keep personal and business transactions separate, simplify your bookkeeping, and make it easier to identify deductible business expenses when tax season rolls around.
- Review and audit business accounts regularly: Regular checks of your business accounts can help you spot and rectify any accidental commingling. An annual or bi-annual audit by a professional accountant can provide a thorough examination of your accounts and ensure you’re keeping your finances in check.
- Keep business expense receipts: The IRS webpage, “What Kind Of Records Should I Keep?” states that valid documentation for expenses must describe the payee, amount paid, proof of payment, date incurred, and the item or service purchased. It’s vital that you keep business expense receipts. We recommend using software like Dext (formerly Receipt Bank) to track and manage your expense receipts without needing to drag around a yearlong paper trail in shoe boxes.
- Use accounting software: There are numerous accounting software solutions available that can help you manage your finances. They not only provide an easy way to track and categorize expenses but also generate insightful financial reports that can help you understand the health of your business better. Our firm uses QuickBooks Online to track and organize financial records for clients and prepare financial statements and real-time reports that inform business planning.
Keep Expenses Separate To Keep Everything Tidy And Clear
Delineating your personal and business expenses preserves the accuracy of your financial reporting so you can make sound decisions in your business regarding profitability and better distinguish deductible from non-deductible expenses during tax season. If you need help with your bookkeeping or find yourself in need of tax advisory services, contact us and learn why hundreds of companies have trusted our team since 2011 to provide accurate, reliable bookkeeping, tax, and controller services.
