Certain things cannot mix well like milk and salt. Similarly, you cannot mix through personal finances and business finances. It is generally recommended that you should not mix through both types of funds because it will create monetary problems.
Having the separate can let you have a clear insight into how much funds you have to meet your personal expenses and how much funds you have to meet your business expenses.
At the time of starting your business, you may have used your personal assets or taken out unsecured personal loans based on the income other than business. Still, It would help if you began to classifying to create a clear boundary between both types of finances. Before you know how you should do it, you must know the importance of segregating expenses.
Why should you separate both the expenses?
One of the most common reasons for keeping both the finances separate is business is a distinct identity. However, apart from statutory compliance, the following are the reasons for doing it.
1- The cost of business
As an entrepreneur, you would always like to know the total cost of running a business. This is essential because you may need to whittle down some expenses and some you would like to cut altogether.
However, the real cost of running a business can be ascertained if you do not club them with personal income. However, there can be some expenses in your books of accounts that reflect a portion of your personal expenses.
For instance, if you visit your office by car, and you use the same car for your personal purposes, fuel cost and maintenance charges should be allocated to both of them.
2- Know the right assets and liabilities ratio
Books of accounts will give you a real picture of financial ratio. A good state of business is considered when you have assets more than liabilities. Make sure that the assets listed contribute to your business.
Adding a deposit to your assets that you will use down the road for your personal purposes cannot be considered an investment because it is not contributing to your business.
If you mix through your business assets and personal assets, you will have a wrong idea about the net worth of your business.
How to separate both expenses
Now that you have got to know why you should classify the expenses. The next step is to understand how to do it.
1- Classify expenses
Try to keep a separate record of personal and business expenses. It can be hard to maintain separate books of accounts, but proper classification can help you manage all of your costs more effectively.
For instance, if you mix through your personal financial obligations like repayments of no credit check loans, it can be hard to apply for a new business loan because it will show that your business has already taken on debt. It is why it is crucial to separate both types of funds.
2- Open separate expense accounts.
There can be some services you would be used for personal as well as business needs. Because of the similarity of expenses, you should open a separate expense account.
For instance, if you have rented a car and use it for both personal trips and business trips. Make sure that you have a record of all charges, including fuel cost and the right method to allocate them to both expenses.
3- Pay yourself a salary
Though you are an entrepreneur, it does not mean that your income is the total amount of profits your business generates. You should fix a particular amount of your salary and withdraw it every month.
The monthly salary will be the income that you will use to meet all your expenses. If you have to borrow money for your personal expenses, you can do it against this income only.
Segregating your personal expenses from business expenses is crucial to avoid monetary issues. Otherwise, you will neither have an idea of how much you are spending on your costs nor how much is going toward your business.