This is a hot topic and can be intensely personal and painful.  The financial relationship that an owner has with his small business can be excellent or it can be one of the largest sources of stress in an owner’s life.  I personally have gone 3 months without taking a paycheck, so not the worst in the world, but not fun.  In the end, I only took a paycheck because I HAD to pay some bills, and not because the business didn’t have a dire need for the money.  We’re all humans with personal needs that evoke strong emotions.  The hard part about money is that when you get low on it, your brain kicks into survival mode and can easily stop being logical about your financial decisions.

Financial stress can lead to blurring of personal and business finance

Reasons to Keep Business and Personal Separate

There are many reasons to keep these separate, I’ll list a few below and then we’ll talk about methods for doing this.

  • Failing to separate personal and business finances can and has been used in court to “pierce the corporate veil”.  This negates you Limits of Liability, which is one of the primary reasons to formin a separate business entity.  This is somewhat circumstantial, so talk to your lawyer about your circumstance if you can’t avoid it.
  • Bad habits are hard to break.  If you’re used to “greying the line” between business and personal, you’re more likely to pay for your personal emergencies by taking an “extra paycheck” whether your business has the money or not.
  • Personal finance has a lot of emotional baggage with it.  If you can’t separate your personal finance from your business finance then that emotion will bleed over into your business and make you into a bad decision maker.  If you separate them, you’re less likely to do “retail therapy” using your business accounts.
  • Your significant other might have different spending priorities than you do.  So they might think that going to the Bahamas is a better idea than investing $10k in an improved business process.
  • Bankers, lenders, and potential investors will run the other way as fast as possible if they see that you are spending business money on groceries or a new car/vacation/groceries for your Wife/GF/SO/Mom/whoever.  The lenders who don’t run are making enough money on you to pay for the insanely high default rate that they have on other similar high-risk loans (aka, ripping you off).

Strategies for Separating Business and Personal Finance

First of all, you need to work on your own personal financial maturity as a business owner.  Once we get away from the personal issues of finance and we focus on the business there are some key strategies.

Get a Separate Business Bank Account

This is probably one of the first things you should do as a business.  Get a separate business banking account and transfer a set amount of money into that account.  Pay all of your business bills from this account and track this account in your Accounting software.

Pay Yourself a Salary

This is one of the best ways to separate things out.  If you pay yourself a salary then you can set a budget at home and at work.  Transfer your pay from the business account to your personal account on a regular basis.  You can pay out bonuses quarterly or annually if you have extra profit that you decide not to re-invest in the business.

If you need a rule of thumb for paying yourself, calculate the average and standard deviation of your net profit.  Then set your salary to the average minus one standard deviation.  This way you’ll have extra money 68% of the time and you should average out to a conservative tradeoff.  If you need a spreadsheet for that, use the Control Charts spreadsheet which does some of those calculations for you.

Get a Business Emergency Fund

All businesses have financial setbacks.  I almost called them unexpected, but that’s a silly lie we tell ourselves.  If all businesses have setbacks, then we should expect them.  Give yourself some breathing room and set aside a $5k or $10k emergency fund.  That should be able to cover a lot of emergencies.  Adjust this number based on the size of your business.

Set a Business Budget

Have an annual budget.  There should be an annual budget planning process which lets you plan out what investments you want to take on for the year.  This should include a few scenarios for if you have more profit than expected or less profit than expected.  Set up a review period either monthly or quarterly to see how you need to adjust that budget as you go.

Use Allocations to Save for Sparodic Expenses

If you find that you regularly need to spend money on tools, then start monthly allocation for tools.  This way you have a specific amount of money you can spend which might help reduce your urge to buy more than you should.

Set up an Approval Process

If you give yourself a standard method of evaluating every business expense before spending, then you can start to control when you spend and when you don’t.  You can include your Accountant in the approvals loop so that you’re being held accountable.  A good trick with this is to have a list of the stuff you really want to buy in front of you at each approval.  Buying decisions should be a prioritization call, not just a yes or no approval of each individual item.

Make Someone else the Financial Decision Maker:

You can hire a CFO to do these things for you.  The CFO can be objective about it and make sure you don’t mix work and personal.

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