Separate Personal Expenses from those of your Business.

Tuesday, March 1st, 2011

This is the next in the series on some of the causes for business distress. This is one which many business owners never consider.

I think it would be fair to say that most owners of small businesses confuse the finances of their businesses with that of their own personal expenses. Many don’t draw a distinction between the two at all. This can have very serious consequences for your business – and for you – if you’re one of those people.

The effects of this are two-fold:

• It creates a false sense of security for the owner – he thinks he is earning a significant income because, subconsciously, he relates it to the cash inflows of the business – and,
• It creates a false sense of security about his business; – he thinks his business is doing well because he is living an above-average lifestyle.

One would think that a quick glance at the income statement will warn them that all is not well, but there are three main reasons why this doesn’t happen:

• The Income Statement is incomplete and hardly ever looked at anyway; and/or
• Personal expenses are written off to business expense accounts (which is illegal).
• The personal expenses of the owner may be allocated to a loan account, which ends up growing faster than the retained earnings of the business.

In order to cater for the increased demand on cash from within the business, creditors are usually compromised and agreed payment terms are extended – and most of the time it is not by agreement. If you are drawing R50,000 a month from your business that only generates a R30,000 per month pre-drawing profit, the surplus drawing can only come from one source – borrowings! If it continues unabated it will prove to be terminal.

It is vital that sufficient analysis is carried out – and this really doesn’t take long to do – to determine the following:

• Exactly how much profit (or loss) the business is actually making. (After excluding all those personal expenses which tend to creep into the monthly business cash flow!!!)
• Exactly how much you, as the owner of the business, need to live on.
• Whether the profit being generated is sufficient to meet those needs and still enable the business to grow organically.

It is my experience that this research is very rarely carried out.

The main motivating factor for managing their finances in this confused way seems to be the desire amongst many small business-owners to pay as little income tax as possible. This is sometimes so prevalent that I often find new business-owners trying to avoid tax when they haven’t even made a profit yet!

I am a firm believer in the right of each and every individual to order his/her finances in such a way as to pay as little tax as legally possible. There are still a number of ways of doing this without incurring the wrath of the Commissioner for Inland Revenue but it requires careful planning, discipline and the right financial structures in place.

If the business is financially well-managed, and all other things being equal, it will make a profit and grow. The income it generates for the business owner will also grow, in spite of the fact that income tax has to be paid. In fact, as a small-business owner, I would rather have a serious tax problem than a business in distress!
If the business is not financially well-managed, it will die – and no amount of tax evasion is going help.

My suggestion to small business owners then is this:

• Analyse your personal financial requirements in terms of your Obligations, Needs and Wants (ONW’s) – and prioritise them in that order.
• Measure those ONW’s against the income being generated by your business, after you have made adjustments for personal expenditure that has been included in your business’ records.
• If the profit being generated is insufficient to meet those ONW’s, make some changes to your personal demands – starting with the Wants!
• Allow sufficient profit to be retained in the business to cater for growth.
• Create a personal budget and open up a private bank account to monitor your personal expenses. Then draw a “salary” each month – and no more!
• Employ the services of a qualified tax practitioner to help you minimise your liability in this regard. The cost will be well worth it!
• After the profit has been made, and a reserve (war-chest) has been created, then you can begin to enjoy the fruits of your labours!