Separating your personal finances from those of the business can have a very positive impact on your cash position.
Many small businesses are run with the business bank account being treated as an ‘open tin' for business owners and their families. If carefully managed and monitored, this may be OK. The problem is, we have rarely seen a situation where it is monitored, and therefore it is mostly a problem!
Unmanaged, it's difficult to know how much of the funds are available and required by the business as well as the business owner. If the business bank balance suddenly goes up, it can be very tempting to pay yourself a bonus, because you think you deserve it. The real question is - can you afford it?
We have seen many examples of business owners getting carried away the minute a big sale is made and using the income to fund personal luxuries. Later they regret spending the business' working capital when finances get tight. This is usually the point at which they need to head to the bank for an overdraft and find they have to encumber the family home to secure funding. In effect the overdraft is required to support their personal spending habits!
Drawing accounts
Drawings accounts are often used as a way for business owners to funnel personal spending through the business, then tally it up at the end of an accounting period and pay the relevant tax. Again, this is fine if you have some kind of control on the situation. A problem occurs when there is no limit on spending.
This situation is often made worse when family members have credit cards on the business account. I have personally seen some horrendous credit card bills from families of business owners, which the business just cannot sustain. Would a business owner allow their employees to take a wage/salary that reflected their spending ability rather than their earning capacity? I think not.
Taking a wage/salary over drawings means personal spending must be disciplined. Employees have to do it, so why not business owners?
Another drawback with running Drawings accounts is that you effectively have to enter every item of personal spending in your accounting system, which can be quite time consuming, costly and not very beneficial.
Treat the business as a separate entity
The best way to manage a business is to treat it as a separate entity from yourself as the business owner. The business must be able to survive on its own merits. If a business owner is constantly dipping into the business' funds uncontrollably, it doesn't stand a chance of surviving.
The finances of each entity need to be managed separately. This begins in both circumstances with a budget. The business needs a budget so that it knows if it will make a profit and be able to meet its cash obligations. The business owner needs a budget so that they know if they can meet their own living costs and obligations.
If from the very start you pay yourself a wage and never pay personal expenses from the business, you'll never have to worry about a big tax bill at the end of the year, because it's been paid throughout the year. You never have to wonder how much of the money in the business bank account belongs to the business and how much belongs to you.
Another BIG benefit of paying a wage is that it ensures you pay superannuation contributions for yourself, in just the same way that you pay them for staff - on a regular basis. This will contribute greatly to the balance of your superannuation fund in the future. I know of business owners who run partnerships and so haven't had to pay themselves superannuation. These same business owners are really going to struggle in retirement, because they haven't had the discipline of contributing to superannuation for themselves.
Your net income should exceed your gross habits!
I urge any business owner to keep their own finances separate from those of the business, in order to manage both sustainably and for the survival of the business.