Some things in life are clear-cut. A Ford or a Holden (a Ford), the Roosters or Storm (Roosters), Sydney or Melbourne (no-brainer).
Others, such as your business and personal expenses, can sometimes get mixed up when you’re self-employed or run a small business.
As you probably know, the Australian Taxation Office (ATO) advises that most expenses you incur in running your business may be claimed as tax deductions to reduce your assessable income.
However, the correct treatment and classification of personal and business expenditure is a challenge that all small business owners face. Let’s run through how you can clearly draw the line between your business and personal expenses.
The ideal starting point is to be absolutely confident of what can be classified as a business expense and what cannot. The ‘at risk’ or grey areas typically include entertainment expenditure, travel and food costs.
While the treatment in most cases may be obvious with due thought, if in any doubt check with the ATO, or consult with an appropriately qualified accounting professional. Once you have the legislation down pat, it’s largely a case of adhering to the rules with discipline and keeping the two expenditure types separate.
And, if you’re honest with yourself, dinner with mates is not and never can be a business expense!
Paying for business expenses using personal funds may be a common occurrence, but this tends to cause the accounting work to be onerous at tax time — and there can be a high cost attached to this.
Large businesses use significant resources for the budgeting process, and they do so for good reason: what gets measured gets done!
At the beginning of the financial year, draft a budget for your business. If possible, allocate yourself a salary, and don’t exceed it. This can be an excellent disciplining mechanism, both for keeping your personal expenditure under control and for ensuring that your business adheres to its budget.
Occasionally, the need to top up the funds of your business may be unavoidable, but the best form of avoidance should include detailed and thorough budgeting.
This is a simple, practical point, and the most effective one.
If you maintain a separate bank account for your business, tax return time can be almost as simple as downloading a complete set of bank statements and categorising expenditure accordingly. This is especially true if you can also have the ability and discipline to use a business debit and credit card for business-related expenditure. Credit card expenditure is the area where expenses are most likely to become confused, so having a separate credit card for your business can assist greatly.
Remember that a business that is incorporated as a separate entity can act as a form of protection for your personal assets in the event of your business being sued. It may, however, be tricky to argue that your business is a separate legal entity if your personal finances are in the mix.
In a similar vein, obtaining financing or business loans may be more challenging where the classification of expenditure is murky or mixed, and in turn this may impact the ability of your business to grow.
Another effective practical recommendation is to keep two separate storage for your receipts: one for business expenditure and one for personal purchases. You can also scan receipts to reduce paper storage. Either way, separating receipts can save you (or your accountant) valuable time at year-end tax time.
Remember, the ATO states: “You must keep records of your business transactions for five years after the records are prepared or obtained, or the transactions completed, whichever occurs later.”
If you have an asset or item that you engage for both your business and for personal use — such as a car, a laptop or a mobile phone — it helps to keep a log of business usage. In an ideal world you might have a separate car for your business and personal usage, but in reality this is rarely the case.
In order to claim deductions for business travel you need specific, documented evidence of the expenses. The good news is that there are now smartphone applications that can make keeping track of usage a simpler exercise.
If you run some or all of your business from home, you may be able to claim part deductions for rent, rates, insurance and utilities. What you are able to claim depends on whether or not your home is your place of business and if you have an area set aside exclusively for business activities. Resolve to keep your office and your home separate, particularly if you do on occasion work from home.
There are tax deductions available for genuine home offices, but clearly the business should not pay the full energy bills for the home — an appropriate split should be allocated.
There has been evidence to show that business owners who keep their personal and business expenditures separate are more inclined to treat their business professionally and, as such, can be outperformers.
On the other hand, those with muddled finances may be more likely to view the funds of the business as an extension of their own personal finances.
If your goal in business is distinction, then keep your personal and business finances distinctly separate — it should be a straightforward and inexpensive exercise with significant benefits. With the right bank accounts, business cards and document storage system in place, the treatment of expenditure should be as clear cut as the choice between Melbourne and Sydney (well, Sydney, of course for me).