Bookkeeping Basics: New business spending from personal accounts
Managing Business Expenses with Personal Funds: A Guide for Small Business Owners
When starting a new business, it's common to use personal funds for business expenses, especially in the initial stages. This is often unavoidable before obtaining an Employer Identification Number (EIN) and opening a business bank account. However, what happens when business revenue consistently falls short of covering expenses, requiring ongoing personal contributions? How do you handle the bookkeeping and ensure you're protecting your personal assets?
This article addresses this critical issue, focusing on the legal implications and providing practical solutions for managing business finances when personal funds are involved.
The Importance of Separation: Piercing the Corporate Veil
Accurate bookkeeping is essential for any business. From a tax perspective, using personal funds for business expenses is generally acceptable as long as you maintain proper documentation (receipts, invoices, etc.) and the expenses are legitimate business costs. However, the more significant concern lies in legal liability.
Limited Liability Companies (LLCs) are designed to protect your personal assets by creating a legal separation between you and your business. This protection can be compromised if a court determines that there's no real distinction between your personal and business finances—a concept known as "piercing the corporate veil."
Using personal accounts for business purposes and vice versa creates a clear indication of commingling funds, which can be used as evidence to pierce the corporate veil. This exposes your personal assets to liability in the event of a lawsuit against your business. Therefore, maintaining strict separation between personal and business accounts is crucial.
Strategies for Managing Expenses When Revenue is Insufficient
When business revenue doesn't cover all expenses, there are several ways to manage the situation while maintaining proper financial separation. Here are three common approaches:
Owner's Contribution (Cash Injection): The most straightforward method is to transfer funds from your personal account to your business account as a formal owner's contribution. This should be documented as "Owner's Equity" or "Paid-in Capital" in your accounting records. It is highly recommended that a formal loan agreement be established between you and the business if the contributions will be repaid.
Example: If your business needs $2,000 to cover operating expenses, you would transfer $2,000 from your personal account to your business checking account and record this as an owner's contribution.
Journal Entry:
Debit: Business Checking Account $2,000
Credit: Owner's Equity/Paid-in Capital $2,000
Business Credit Card Paid with Personal Funds: Using a business credit card (under the business EIN) for business expenses and then paying it off with personal funds is another viable option. This keeps the business transactions separate. The payments made from personal funds should be documented as owner contributions. It is highly recommended that a formal loan agreement be established between you and the business if the contributions will be repaid.
Example: You use your business credit card to purchase $500 of office supplies and then pay the balance from your personal checking account.
Journal Entry (Payment):
Debit: Business Credit Card Payable $500
Credit: Owner's Equity/Paid-in Capital $500
Direct Payment from Personal Account (Least Preferred): While less ideal, if you directly pay a business expense from your personal account, you must meticulously document the transaction. Record the expense in the appropriate business expense category and credit an "Owner's Equity" or similar account. It is highly recommended that a formal loan agreement be established between you and the business if the contributions will be repaid.
Example: You pay a $100 business utility bill from your personal checking account.
Journal Entry:
Debit: Utilities Expense $100
Credit: Owner's Equity/Paid-in Capital $100
Managing the First Few Months: A Practical Example
Let's revisit the initial scenario of a lawn care business started in April 2018. The owner used personal funds for initial equipment purchases and received payments into their personal account for the first five months.
The initial equipment purchases should be documented with receipts and recorded as assets on the business balance sheet, with the offsetting entry to owner’s equity. The income received in the personal account should be recorded as owner contributions to the business. Once the business obtains an EIN and opens a business bank account in October 2018, all future transactions should flow through the business account. The $5,000 transfer from the personal account to the business account should be recorded as an owner’s contribution.
Key Takeaways
Maintaining separate personal and business finances is crucial for protecting your personal assets.
Document all transactions meticulously, especially when using personal funds for business purposes.
Prioritize using business bank accounts and credit cards for all business transactions.
Formalize owner contributions with proper accounting entries and formal loan agreements.
By following these guidelines, you can effectively manage your business finances, even when using personal funds, while minimizing the risk of piercing the corporate veil and protecting your personal assets.
