A key principle in running a successful business is the maintenance of proper business records of income and expenditure. This enables owner(s) not only be able to read into the performance of the business but also the commercial and regulatory environments dictate this as a good practice. Aligned to this, is a principle recognizing a company as a separate person altogether from its owners. This very act of separating the business from its owners is often a challenge in small business environment and often rated one of the factors leading to the demise of such businesses. A small business environment is mainly characterised by a mixture of business and personal transactions. Separate accounting enables the business owner to get a good view of the business performance and to properly comply with their various statutory obligations amongst them payment of taxes.
Tax demands for separation of finances
There are compelling reasons to be proactive about distinguishing between business and personal finances. Tax implications are foremost. The tax authority allows business owners to claim deductions for business-related expenses supported by proper documentation. If your business is audited, the tax authority will look closely at each expense to verify that it is indeed related to the regular operation of the business. When there is no clear paper trail in terms of what the expenses were for, or how you paid for them, it becomes more difficult to validate the deduction resulting in the ZIMRA raising an assessment against the company which will include penalties and interest. Every business transaction has tax implications and in terms of the tax laws, every person who carries on a trade is obliged to account for tax in respect of the income they generate from the trade. If there is no separation between business and private finances, it is difficult to distinguish between the transactions relating to each aspect. As a consequence, it will become difficult to determine the correct tax to be declared and paid to the taxman. Because a business is allowed to claim only business-related expenses that are supported by proper documentation it is in the best interest of the business to separate these expenses. Small businesses should be proactive about this and should make sure they keep the supporting documentation (invoices, receipts, etc.) for their business expenses because the burden of proof lies on them. They are required to prove that their business expenses are legitimate failing to do so they will be penalised. Meanwhile expenses for travelling between home and place of work or vice versa are regarded as private expenses and owners for instance are not permitted by the tax law to deduct fuel and other motor vehicle running expenses associated with travels or journeys.
Other commercial demands for separating finances
Besides the regulatory demands, absence of proper accounting systems may lead to many problems which include theft of stock and funds which may go unnoticed over a long period of time. A business without records is like a car running without engine oil, it will definitely come to a halt. It may be difficult to ascertain whether the business is making any profits or to take corrective action when things are not as planned. A separation is also important when considering owner liability for debts. This underlines the principle of limited liability in limited companies where creditors are not allowed to attach personal assets of shareholders in the event of the company unable to pay its debts. However when there is no clear distinction between business and personal finances, creditors can claim your personal assets to satisfy a debt. For instance the ZIMRA is permitted to recover unpaid tax from the shareholders or directors who have transferred any amount or asset from which tax has become due to themselves or a relation with the intention of avoiding paying tax. Targeted transactions include drawings of shareholders to pay for personal expenses, expropriation of company assets, physically transfer of assets or amounts that are not supported by paper work etc. Tax recovery measures often employed by the taxman include garnishing of bank accounts, filing an order for liquidation or sequestration order, property attachment, imprisonment etc. Bankers to advance loans require accounting books records and are sceptical of accounts containing personal expenses of directors or owners.
Pay yourself a salary
Owners running their business on a day to day basis are more likely than not to deep their hands in the company till as justification for their remuneration if they not on payroll. When you are thinking about your business expenses, one of the easiest items to overlook is your own salary. If you are not allocating funds for your own salary, your books do not accurately reflect the health of your company, since your expenses are missing a large cost, namely you. Without factoring in all expenses, you won’t know if you need to raise prices, market more, cut costs or make other adjustments that will help your company succeed. Besides, how are you expected to pay your bills such as your living expenses, fuel to travel to work, school fees for your children among other domestic and private expenses. These must be paid from your salary or savings and not from funds of the company. A company is a separate person from you and has its own expenses to pay including your salary.
Running a business requires discipline often exhibited by owners staying away from the company till. They should have separate bank/mobile money accounts for personal transactions and for business transactions. A business may have a positive cash flow while having no profit if the cash comes from sources other than income, such as when an owner puts in his/her own money or if he/she takes out a loan. These types of transactions are not income but rather liability or equity transactions. Conversely, a business can have negative cash flows while having a large profit if the owners take cash out of the business (drawings) to pay personal expenses or use it to make investments or loans to others. These types of cash out transactions to meet private expenses have to be accounted properly, mixing transactions result in incorrect tax liability. Under-declaration of tax is a serious offence in terms of the tax laws and attracts hefty penalties and interest on the part of the taxpayer.