Certain things just don’t mix well — like a good scotch and judi online, 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.