Ramesh, a promising young entrepreneur, needed a loan for his business. He had a good personal credit history. His borrowings were few and he had a timely repayment record. He wished to use his strong credit history to get a low-interest individual loan for his business. So, he consulted Sunil, a seasoned businessman with a great understanding of finance. Sunil advised him to keep his business and personal credit separate.
Sole business owners often make the mistake of taking individual loans for their business. But combining business and personal credit can be a problem. It can jeopardise your financial health and that of your business. Here is how:
To begin with, business and individual loans are different products. Individual loans are only meant for buying personal assets or meeting personal expenses. Business loans include bank overdraft, collateral-free SME loans, and various kinds of long-term loans. They are tailor-made for specific business needs.
By mixing up these loans, you are trying to fit a square peg in a round hole. You will end up forgoing the benefits of these products and complicating matters for yourself.
For efficient financial management, you need to be aware of your inflows and outflows. Taking a personal loan to invest in your business blurs the distinction between personal and business funds. To prepare effective household or business budgets, you need to know your costs and earnings.
Also, in the case of an individual loan, the bank has a claim on your personal assets. If your business goes broke and you cannot pay the personal loan, the bank can seize your assets. In the case of a business loan, the bank will have to stop at the business’s assets.
Distinct credit records
When you apply for an individual loan to start a business, the bank will look at your credibility. If your business struggles and you cannot repay the loan, your personal credit score will take a hit. You may find it difficult to take a business loan in future.
But, if you start the company using a business loan, you will get it on the business’s strength. Your credit score will not be affected much if the business cannot repay the loan. By keeping different accounts, you can show a distinction between personal and business profits. This will make it easier when borrowing money in future.
Ease of taxation
Even a small business needs to maintain proper accounts and have them audited for tax purposes. The accounts must show the funds that came into the business and how they were used. When you infuse personal borrowings into the business, the business’s accounts become suspicious. This may attract an audit from the tax department.
The bottom line
Business and individual loans are meant to serve different needs. Using them interchangeably can deprive you of their benefits and result in financial distress. Your business is a separate financial entity and its borrowings must reflect that.