No, it doesn’t “all come from the same place anyway”!
The biggest legal implication when it comes to managing business finances is co-mingling. When a business entity is formed (LLC or corporation), it comes with a liability shield that protects your personal assets from business liabilities. To keep it in place, you must treat the business entity as separate from yourself. That’s why co-mingling is so dangerous – if you co-mingle business and personal funds or expenses, the business entity is not being treated separately from you personally.
What is Co-Mingling?
Co-mingling is evidence used to “pierce the corporate veil” – in other words, it’s used to show that you should be personally liable for your business debts and obligations.
How can co-mingling happen? Here are just some of the ways:
• You use a business check or credit card to directly pay for personal expenses.
• You use a personal check or credit card to directly pay for business expenses (more on this below.)
• You deposit client or customer checks into your personal bank account.
• You don’t document transfers between a business account and a personal account (i.e. for distributions, loan repayments, etc.).
The General Rule
The general rule to follow is: Always use business funds for business expenses and personal funds for personal expenses – and business deposits always go into the business account.
Yes, I know that some business funds need to make their way into your personal account (so you can get paid!) and, at times, some personal funds need to be used to keep the business going.
When you are paying yourself (compensation, distributions, or repayments), the preferable method is to write yourself a check from the business bank account. Be sure to document the payments so that they show up accurately in your bookkeeping.
The same goes for those times when you put personal money into the business – deposit a personal check into your business bank account. And document it very carefully!
Do not get caught up in the idea of “Oh, I’ll just pay this business bill with personal money – it all comes from the same place anyway.” NO, IT DOESN’T! That is the point. You and your business are not the same. You are different and separate – and you need to keep it that way.
It’s very important that you have good business bookkeeping and records. I suggest that you create protocols for yourself to follow when paying business expenses and making business deposits. The more organized you are, the healthier your business will be – and you’ll be better able to track your business progress using financial metrics (more on that in a later blog post).
The Start-Up Exception
Clients who are starting a business often ask me how to handle the funds needed for start-up costs. This is an exception to the rule above – but it’s a limited and managed exception. You can’t get a business bank account until the business entity is officially formed. In the meantime, you have expenses to pay to get the business going, so you are going to have to use your personal funds. In this situation, you need to meticulously document each expenditure so that it can be captured in the bookkeeping once the business gets going.
I recently had the pleasure of interviewing Brent Ross, CPA from Ross Hughes & Associates for our new podcast series called Elevate Your Business (launching soon!). During my interview with Brent, he had two great tips for making this easier:
#1 – Set up a new bank account (it will be a personal account) and deposit some funds (make a guess as to what you’ll need – you can always replenish). Use this bank account to pay for all start-up costs. Even though they are personal funds, they are separated from your mainstream personal funds. Then the account records can help you to reconcile your bookkeeping once you have your business set up. This is an easy way to create a record trail for your start-up costs – instead of the time-consuming task of combing through all your personal bank account statements.
#2 – In addition to or instead of a separate personal bank account, you can get a separate personal credit card to use for start-up costs. It would work the same way – you pay for all start-up costs with this one credit card. The records are all there for you to capture later in your bookkeeping.
Not only does this system help you with record-keeping, but it also gets you in the habit of using a separate source of funds for business expenses. These two tips are great – and Brent had many more so you’ll need to listen to the recording!
The Rare Exception
Even after saying that you can’t co-mingle your personal funds with your business funds, I know there are rare times when you have to pay a business expense with personal funds. For whatever reason, this does happen. You just need to make sure that it is RARE and when you do it, you fully document it. It needs to appear in your business bookkeeping in one way or another – as a reimbursable expense or as a capital contribution.
Do not set up business procedures to regularly pay business expenses with a personal account (bank or credit). This is a sure way to get caught up with co-mingling. If you need to pay with a credit card, get a business credit card for those types of purchases.
Bottom Line = Do business mingling all you want, but NEVER co-mingle!