Decision fatigue can quickly set in when starting a business — from choosing a business structure, logo and brand to figuring out what licenses are required and the products you’ll offer. Compound these tough first decisions with all of the confusing jargon used by lawyers and accountants, it is easy to see why many new business owners eschew the more mundane financial and legal aspects of their businesses in favor of focusing on the core product or service they provide. While you may be tempted to declare yourself too busy or not knowledgeable enough to take charge of the financial nuts and bolts of your business, ignoring basic financial housekeeping can have dire consequences. Among the rookie mistakes common to new business owners (and some seasoned business owners too), one stands out as more common and more important than the rest:
THE biggest mistake new business owners make is NOT separating business finances from personal finances.
If you are not yet convinced that it is important to separate business finances from personal finances and would prefer to get back to doing what you do best (or that Netflix marathon), below are some reasons why “keep ’em separated” should be your new mantra (bonus points for anyone who gets the musical reference):
1. Limited Liability Asset Protection:
Setting up your business as a corporation or a limited liability company (LLC) is a way to protect your personal assets in the event your business cannot pay its debts or you are sued. However, mixing business and personal finances together potentially removes that protection and you could be held personally liable for the debts of your business if no separation is in place. One of the driving reasons behind establishing a business entity (like a corporation or LLC) is the protection of personal assets but not separating business finances from personal finances essentially renders that protection null and void. If you don’t want your house or other personal property to be up for grabs if creditors come knocking, keep your personal finances separate from the finances of your business. If you don’t have a business entity, you may want to start thinking about setting one up to protect your personal assets (if you need more information on how to set up an LLC, Incfile has you covered). Even if you are operating as a sole proprietorship with no official business structure, it is still a good idea because of the next three bullet points — financial tracking, sanity and mental clarity, and building business credit.
2. Business Bookkeeping & Expense Tracking:
As unappealing as it might be, keeping track of the finances of your business is incredibly important for many reasons. First off, claiming all allowable business expenses is an easy way to reduce taxes and keep more of your hard-earned cash. However, if all of your finances are mixed together, how will you know whether that steak dinner was to celebrate your birthday or a meeting with an important client to discuss business? Jumbling all of your personal and business expenses makes it nearly impossible to sort out the business expenses from the personal and basically guarantees that you will miss some business expenses (and therefore pay more in taxes – yikes!). If you are working with a bookkeeper, keeping your business and personal finances separate makes your bookkeeper’s life much easier (and because it will take them less time to keep your books up to date, they will charge you less as well). In addition to saving you money on taxes and making life easier for whoever is in charge of company bookkeeping, keeping track of the financial health of your business is crucial in its own right. Information is power so it is important to know how much your business is making and spending at any given time. Was cash tight in October because you invested in spending money on marketing for your business or because your ordered in one too many times? Keeping your business finances separate enables you to better understand the financial health of your business and equips you to make better business decisions.
3. Sanity and Mental Clarity as Business Owner:
The lines between business and personal life are more blurred than ever before. Many people work from home which can make it feel like work time is “always.” Even those who work in traditional offices often respond to email or other work related requests in their downtime. Drawing a line between your business life and personal life is important for mental clarity and as a way to make time to recharge. While there are many ways to separate personal life from business life, separating finances is one important tool. Physically separating money can help with mental clarity and greater work of more generally separating personal life from business life.
4. Establish Your Business Credit:
Business credit is important for a business as borrowing is often required to make big purchases or keep the business afloat when cash is tight. Mixing business and personal finances will hinder your ability to build a financial identity for your business and therefore impedes the ability of your business to create a strong credit history. Without a solid credit history, it will be hard for your business to borrow money. Keeping business finances separate from personal finances is one way to start building a financial identity unique to your business and to improve your business’s borrowing power in the future.
Hopefully by now you agree that separating business and personal finances is a good idea. Maybe you even feel a little bit guilty about not doing it sooner. Now the question is: how do you do it?
- Open a new checking account: If you have a business entity like an LLC or a corporation, make sure the new account is in the name of your business. If you do not have a business entity, simply open a new account in your own name. In either case, make sure that this account is designated as only for the business from now on.
- Open a new savings account: While you are opening accounts, you should also open a new savings account for your business. Even if you don’t earn much interest, savings accounts are useful for saving up for taxes or a big purchase. Putting money aside out of your main checking account will help you keep it separate from the cash you need on hand to run your business.
- Switch Electronic Payments: If you receive electronic payments (like through PayPal), update your information so that all the electronic payments now go into your new business bank account.
- Get a Business Credit Card: Getting a credit card in the name of a new business can be tricky and you may have to start with a small credit limit but you should try to get a business credit card anyway. Like a separate checking account, having a separate credit card helps with your record keeping by keeping business expenses separate from personal expenses. An added bonus is that any interest you pay on your business credit card counts as a tax deduction (whereas interest from a personal card does not). If you cannot get a credit card in the name of your business, at least separate out one personal debit card and use it exclusively for business purchases.
Once you have followed the steps above, you are ready to go. From now on, make sure all business revenue goes straight into your business bank account. Use the business account and credit card for all business expenses.
Here is the part where we get to the most common reason given for not separating business and personal finances: what happens if you need to move money from your business account to your personal account or vice versa? The answer is actually very simple, just transfer money from one account to the other.
- Transferring Money from Personal Account to Business Account: Move the money and be sure to mark it as a loan. It is important to record the amount as a loan so you don’t accidentally count it as business income which is taxed. Loaning the business money from your personal account is not considered income and therefore will not be taxed.
- Transferring Money from Business Account to Personal Account: Move the money whenever you want, nothing special you have to do here since you are just paying yourself. You don’t get to write off payments made to yourself as tax deductions for the business but you can pay yourself from the business account whenever you want. If you are using the same bank, it is easy to transfer money electronically. Otherwise, you can write yourself a check from your business account.
Many business owners start out with commingled business and personal finances so don’t feel bad if you do too. With a few simple steps, you can untangle your business and personal finances for good. When is a good time to get started? I suggest right now!
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