As business owners, we often find ourselves focusing on the financial health of our companies, striving to hit targets, manage cash flow, and drive growth. However, what many overlook is the significant impact that personal financial health has on the business. At Tentho, we’ve seen firsthand how the lines between personal and business finances can blur for our members, leading to detrimental effects on both fronts.
Personal Finances: The Hidden Business Risk
Personal financial mismanagement can pose a serious risk to your business. When business owners are not honest with themselves about their personal spending and goals, they might find themselves dipping into business funds to cover personal expenses. This not only disrupts cash flow but also derails strategic business plans.
For example, consider a business owner who frequently takes large distributions from the business to fund personal purchases such as a second home or a boat. While this may seem manageable at first, the sudden withdrawal of significant amounts can cripple a business, causing chaos for operational departments that were relying on that cash for business sustainability or growth. This can derail planned business goals. And this scenario is not uncommon amongst small business owners and highlights the need for clear boundaries and better financial planning.
Separating Personal and Business Finances
It’s crucial to maintain a clear separation between personal and business finances. This separation helps in:
- Accurate Financial Reporting: Clear boundaries ensure that your business financial statements reflect the true financial health of the business without being skewed by personal withdrawals. This also make tax preparation easier at yearend without having to manually remove personal expenses from your bank statements for your CPA.
- Better Financial Planning: When you know the amount of salary or distribution needed for your personal household budget this can be built into your business budget the same way any salaried position is included. This ensures that throughout the year the business is able to plan for distributions to the owner rather than be cash poor due to sudden and frequent distributions. This makes it easier for the business to plan for growth, invest in new opportunities, and manage cash flow effectively.
- Reduced Risk: Keeping personal and business finances separate reduces the risk of personal financial issues affecting the business. For example, personal debt or financial emergencies won’t force you to dip into business funds.
Real-Life Examples and Mistakes to Avoid
Example 1: The Sudden Cash Withdrawal
Imagine a business owner who suddenly withdraws $100,000 from their business account, without prior adjustments to the business budget, to cover personal expenses. This unexpected withdrawal led to cash flow problems, resulting in delayed supplier payments and strained relationships with key vendors (and key employees)! This kind of financial mismanagement can create a ripple effect, affecting everything from reducing operations to key employees leaving the company.
How to Avoid It:
- Plan Withdrawals: Schedule regular, planned distributions that align with the business’s cash flow.
- Communicate: Ensure any key employees or stakeholders (involved in the business financial management) are aware of personal needs for significant cash withdrawals. Transparency is best so that all parties can work toward personal and business goals together.
- Emergency Fund: Maintain a personal emergency fund to handle unexpected personal expenses without dipping into business funds. The business bank accounts are not your emergency fund.
Example 2: Personal Debt Impacting Business Decisions
Consider a business owner struggling with personal credit card debt or significant amounts due to the IRS, who began using business funds to pay off personal debts. The owner could be more inclined to encourage a business loan. However, the problem is not cash needed for the business. The problem is the personal debt of the owner. The business loan would be taken out for the wrong reasons and could be financially detrimental if it is not used for growth purposes or for the business. The mix-up between personal and business finances led to a lack of clarity, making it difficult for the owner to make informed business decisions. Ultimately, this can result in penalties from the IRS and/or from financial institutions.
How to Avoid It:
- Separate Accounts: Always use separate bank accounts and credit cards for personal and business expenses.
- Debt Management Plan: Create a personal debt management plan to tackle personal debts without negatively impacting business finances.
- Financial Discipline: Practice financial discipline by sticking to a personal budget and avoiding unnecessary debts.
Example 3: Inconsistent Personal Spending
Consider an owner who frequently takes money from their business to support a lifestyle beyond their means, purchasing luxury items and funding extravagant vacations. The lack of a personal budget and acceptance of their personal financial position led to a cycle of financial instability, impacting the business’s ability to maintain steady operations and plan for the future. This erratic behavior often left the business scrambling to cover shortfalls, impacting long-term strategic planning. If a business partner is involved this can also cause contention between business partners.
How to Avoid It:
- Personal Budget: Create and adhere to a personal budget to manage expenses within your means.
- Financial Goals: Set clear personal financial goals that align with your business objectives.
- Regular Reviews: Conduct regular financial reviews to ensure personal spending is in check and not affecting the business.
Example 4: The Personal Savings Cushion
A study by Jessie Hagen of US Bank found that 82% of small business failures are due to cash flow problems. One contributing factor is the lack of personal savings. Business owners without a personal financial cushion often resort to dipping into business funds during personal financial emergencies. For example, an owner facing unexpected medical bills might pull from business reserves, disrupting cash flow and operations.
How to Avoid It:
- Build an Emergency Fund: Establish a personal savings cushion to cover unexpected expenses.
- Insurance: Various insurance policies to mitigate the financial impact of emergencies.
- Regular Savings: Make regular contributions to personal savings to build a robust financial cushion.
Example 5: Missing Out on Investment Opportunities
Research by the National Federation of Independent Business (NFIB) shows that business owners with strong personal financial management are more likely to invest in their businesses. Those with poor personal financial habits often miss out on growth opportunities.
How to Avoid It:
- Debt Reduction Plan: Work on reducing personal debts to improve financial stability.
- Investment Planning: Align personal financial health with business investment opportunities.
- Consult Advisors: Seek advice from financial advisors to create a strategic plan for both personal and business finances.
Conclusion
At Tentho, we believe that strong personal financial management is the foundation of a successful business. By understanding and managing your personal finances effectively, you can make better business decisions, reduce financial stress, and set your business on a path to sustainable growth. Let’s make a commitment today to prioritize our personal financial health for the betterment of our businesses.
If you need assistance in creating a personal financial statement or advice on managing your personal and business finances, our team at Tentho is here to help. For more insights how to approach household money management conversations, be sure to check out Helen’s post on 10 Years of Love and Money.