Why It's Crucial to Keep Your Business and Personal Finances Completely Separate

Business.com / Finances / Last Modified: September 8, 2017
Photo credit: domnitsky/Shutterstock

One of the many advantages of owning your own business is the freedom to manage processes on your own terms. For small business owners, this can mean combining personal and business finances.

One of the many advantages of owning your own business is the freedom to manage processes on your own terms. For small business owners, this can mean combining personal and business finances. The smaller the business, the more blurred the line between business and personal often becomes.

Maybe you used your personal credit score to secure a small business loan, or maybe you haven't applied for a business-specific credit card and charge business expenses to your personal card. Unfortunately, these practices can cost you. As a sole proprietor or small business owner, there's very little distinction between your finances and the finances of your business – unless you make one.

Taking a few simple steps, like the ones below, can help save you a lot of time and headache, especially when it comes time to file your taxes. 

Set up separate bank accounts

It might seem obvious, but many sole proprietors and small-business owners don't immediately open a separate checking account for their business. If you do, you'll establish a clear delineation between your personal and business finances.

The distinction is particularly useful during tax time. If the IRS audits your business or has any questions about whether your venture is legitimate, one of the first things they'll look for is a separate checking account.

Additionally, when it comes time to file your tax returns, separate bank accounts keep everything organized, allowing you or your accountant to clearly and accurately account for income. This is especially important if you've managed to raise funding for buying a business.

Open a business credit card

Getting a business credit card isn't as straightforward as getting a personal card, but if you need a line of credit, a business card can create separation between your business and personal finances.

What's more, unlike personal credit cards, credit card interest is deductible as a business expense. Just be careful. Debt must be related to business activities. You can get yourself in trouble by charging personal expenses to your business card and attempting to write off the interest later.

Create a clear boundary with family and friends

Even as you invest valuable time and money into your business, it can be easy for family and friends to assume it's your hobby. Set clear boundaries and tell family and friends that the business is your job so everyone is on the same page. The business card isn't for charging the week's groceries or for online shopping, it's for business expenses only. Your business is real, and the success or failure of it will have a significant impact on your life. Make sure everyone close to you sees it that way too.

Hire an accountant and financial advisor

Plenty of small business owners are tax and financial experts. Others wouldn't know a tax return from a balance sheet. If you fall somewhere closer to the second group, it's a good idea to work with an accountant and financial advisor to help with the more complicated aspects of your business's finances.

Advisors can be particularly helpful in situations where you or a family member intentionally mix personal and business financials by investing in the business. An accountant can advise you on how to record the transaction and satisfy any tax requirements.

Set a budget, including your salary

The easiest way to get yourself in financial trouble is breaking your budget or not setting one in the first place. Desperation is dangerous. Plenty of small business owners fall into a trap of trying to make up the difference from financial shortfalls with personal funds.

The best way to avoid that scenario is working with your accountant and financial planner to set a budget and a salary for yourself. You deserve to reward yourself for any success your business experiences, but don't take out more money than the business can afford.

Establish a business entity

Establishing a limited liability company (LLC) or S Corporation creates a clear distinction between your personal finances and your company's. It also adds a layer of protection and insulates your personal finances in the event your business is sued or audited by the IRS.

Discuss your options with your advisors. Both LLCs and S corps provide limited liability protection, but S Corps are more restrictive. S corps are limited to 100 owners or shareholders and U.S. citizens and residents, and cannot have subsidiaries.

In the early days as a business owner, it's easy to overlook the distinction between personal and business finances. However, with a little foresight, you can save yourself a lot of trouble and avoid costly tax or legal penalties. If you're considering buying or have recently bought a business, reach out to an accountant and financial planner to discuss the best ways to separate your personal and business finances.

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