Small business owners often compensate their work at their company in the form of a salary as well as using the company’s cash flow to pay for additional expenses in their everyday lives. This might include cars or transportation, cell phones and other technology, as well as a variety of other expenses. In fact, many of these expenses should never reach the balance sheet of a business. Any small business owner knows that the lines can easily get blurred between personal and business expenses when your life revolves around your company. Where this type of accounting can become a problem is when a small business needs to borrow money. What happens is now the business owner is using a business loan to finance his or her personal life. This results in money costs not justified with profit or opportunity and it is a recipe for failure. Any small business owner that requires funding should make sure that they separate personal and business expenses if they have any plans on building a successful company.
Small business loans are very common for companies during the growth stages. On one side, you may recognize an opportunity to expand the company. This may involve opening another location, expansion through construction or inventory, or simply recognizing an opportunity in the market in one form or another. On the other side, it is not uncommon for a company to go through tough times in the first few years and need some sort of funding to keep the operation going. Simply put, there are a myriad of reasons that could create the need for additional funding for any young business. Knowing that your company is likely going to need money it is better to address the separation of expenses from the beginning.
Unless you hit it out of the park from your first week in business you are likely to need a business loan at some point. If you are a business owner that has all of your personal expenses tied to the company’s cash flow when the time comes to acquire the funding it will be very difficult to separate all of your personal expenses in the moment that a financial crisis arises. Financial problems are almost always immediate and they put you in a position where time is at a premium. Sitting down digging through all of your expenses is going to be the last thing on your to-do list.
The most basic reason for the separation of business and personal expenses is to determine whether or not the business is successful. Every business owner is different and so are their expenses and tastes. So as an example, if you have two mirror businesses that generate the same amount of money and profit, but they have two very different owners who both draw off the business for their personal expenses, one company could be very successful in profit and overall statistics but it is failing because of the strain from the owner who is a spendthrift. It is easy to see why a business should only pay expenses associated with the operation of the business.
The same rule can be applied to managing personal expenses. As the business should not pay the personal, the personal should not pay the business. If you separate all of your expenses you will be able to recognize if you are coming out of pocket for your business. Just as the success of a business may be hard to recognize with improper accounting, its failure can also be masked. You could be burning through your personal money in a failing business and not aware of it because you do not have the expenses clearly defined. When the bills become so intertwined it is easy to lose the ability to recognize failure.
Another potential risk of not managing the expense sheets correctly when taking a business loan is that it becomes difficult to determine if the loan itself was beneficial for the business. As an example, a good time to borrow money is when the potential profit or opportunity that is presented generates more money than the cost of the loan and the interest over a period of time. If there are unnecessary expenses coming into the company and being paid with the business loan then there is a possibility that the company will be deprived of sufficient funding. Any ongoing initiatives may be shortchanged because the funding simply ran out. Not only can this create debt that may not get repaid, it could potentially lead to dissatisfaction with the entire business loan process and the complete rejection of funding at a later date when borrowing may actually be the right decision.
Just as it has been emphasized to separate expenses, it is just as important to separate loans. Using a business loan to pay off your personal expenses sounds as bad as it is. The main problem is that a business loan can only make sense if it generates more money than the entire cost of the loan and paying your Arby’s bill is not really a good profit opportunity for your company. A business loan is meant for a business, and the costs associated with that loan are intrinsically tied to a business’ financial structure; hence the name business loan. It is for this reason the there are different loans for the personal sphere.
Just like there are times where borrowing for a business can be advantageous, it can also be the case with a personal balance sheet. If you find that your salary is not paying the bills and a personal loan would allow you to save money over a period of time versus carrying the debt or payments as is, it may very well be a good idea to borrow personally. It is also likely that the cost associated with a personal loan will come in at a lower rate compared to a business loan because it is tied to a personal financial structure. Whether or not you need additional funding personally, structuring a loan outside of your business makes financial sense.
The first thing to do is make a list of every single expense you have, whether business or personal, if the money goes out it should be on the list. Determine what should be attributed to personal expenses and what should be in the company’s expenses and separate them accordingly. When determining what expenses go where it should be noted that a business owner’s salary should be commensurate with position and experience. Many business owners just take a salary based on personal needs or expectations and not what the position warrants. Accounting with these ideas in mind is a prudent an efficient way to manage any expenses you encounter.
There is no doubt that any successful business requires very thorough accounting and excellent financial management. Many small business owners utilize their business to pay for personal expenses when a business should only pay costs associated with operating the company. This type of behavior can hurt a business over the long term and limit its chances of success, especially when the company requires a business loan from an outside resource. When a business loan begins paying personal expenses it increases the possibility of failed company initiatives and missed opportunities. In order to avoid this type of financial pitfall a small business owner should keep track of every expense no matter how small it may be, and have a clear line of separation between what is a business expense and what is a personal one.
