How to Avoid Commingling Funds in Your Business

Commingling funds describes the practice of mixing personal finances with business finances, or in some contexts, mixing client funds with a business’s operating funds. This often occurs when business owners use company accounts for personal expenses, use personal funds for business costs without proper documentation, or fail to clearly separate transactions in their accounting records. For example, depositing business income into a personal bank account or using a business credit card for personal purchases are common forms of commingling.

Establishing Separate Accounts

Establishing distinct financial structures is an important initial step in preventing commingling. This involves setting up separate bank accounts for business and personal finances. For entities like corporations and partnerships, a separate Employer Identification Number (EIN) is mandatory, and even single-member LLCs or sole proprietorships with employees need an EIN. The EIN, a nine-digit federal tax ID number obtained from the Internal Revenue Service (IRS), is essential for opening a business bank account and for tax identification. Using a separate business account provides a clear distinction between personal and business assets, which is important for LLCs and corporations to maintain liability protection.

For professionals who handle client money, such as lawyers, real estate agents, or property managers, client trust accounts are important. These accounts, often referred to as Interest on Lawyers’ Trust Accounts (IOLTAs) or escrow accounts, are legally and ethically required to keep client funds separate from the professional’s personal or operating funds. For instance, lawyers deposit client retainers or settlement proceeds into IOLTA accounts. In real estate, escrow accounts hold funds, such as earnest money deposits or tenant security deposits, until specific conditions of a transaction are met. These dedicated accounts protect client funds and underscore the fiduciary duty to manage money that does not belong to the business.

Implementing Daily Financial Practices

Once separate accounts are established, maintaining the distinction between personal and business finances requires consistent daily practices. Meticulously categorizing all income and expenses is important. Utilizing accounting software or detailed ledgers helps track every transaction and ensures clarity regarding the purpose of each financial movement. This consistent classification supports accurate financial reporting and makes it easier to identify legitimate business deductions for tax purposes.

It is important to use the correct account for specific types of payments. Business expenses should always be paid from business accounts, and personal expenses from personal accounts. Such practices can make it difficult to ascertain the true financial health of the business and can lead to inaccuracies in financial records.

Handling owner’s draws, salaries, and reimbursements properly is also important. An owner’s draw involves taking funds from the business for personal use, which is common for sole proprietorships and partnerships, while a salary is a fixed payment seen in corporations. These transfers should be clearly documented as either an owner’s draw, salary payment, or reimbursement, not as regular business expenses. If personal funds are used for a business expense, or vice versa, the transaction should be reimbursed and thoroughly documented to maintain clear financial records.

Conducting Regular Financial Reviews

Periodic oversight and verification are necessary to ensure that commingling has not occurred and to identify any accidental instances. Bank reconciliation is an important process that involves comparing the company’s internal financial records with its bank statements on a regular basis, ideally monthly. This comparison helps identify discrepancies, such as outstanding checks or deposits in transit, and ensures that all transactions are accurately recorded.

Regularly reviewing financial statements, including profit and loss statements, balance sheets, and cash flow statements, helps identify unusual transactions or fund movements that might suggest commingling. Examining these statements can reveal inconsistencies in revenue recognition, expense recording, or other financial reporting areas that may indicate issues. For example, significant deviations or unexpected changes in expense categories without a corresponding increase in revenue could signal inaccuracies.

Conducting periodic internal or external reviews further ensures adherence to established financial separation policies. Consistent financial review practices enhance the credibility of a company’s financial reports for investors and creditors. It is also important to retain all financial records, receipts, and bank statements as proof of separation. This documentation provides a clear audit trail and supports the integrity of the business’s financial operations.