There are several logical reasons why every business owner should separate their business finances from their personal funds. But the simplest reason is this: your business — whether it’s an LLC or corporation — exists as a separate legal entity from you as an individual, and it needs to be treated that way for financial purposes too.
When you need to get an accurate picture of your business finances, you might accidentally overlook expenses or make poor business decisions if your personal purchases are intermingled with your business ones. Keeping your business and personal finances separate also has obvious advantages when reviewing your bank records for purchases that qualify as tax write-offs. You don’t want to miss a deduction because you weren’t able to organize your financial statements! By keeping your business and personal finances clearly separate, you can feel a little better at tax season, knowing that you won’t have the extra stress of sorting through dozens of questionable expenses from months ago.
It’s important to understand both the benefits of separating your business finances from your personal spending and the dangers of not doing so. If you haven’t already done so, there are a few simple ways you can start separating your business and personal funds, so you can get your business finances back on the right track!
Risks of Not Separating Business and Personal Finances
Entrepreneurs, startups, and small-to-mid-size businesses work at a fast pace, and it’s not always easy to stay organized or keep track of every dollar coming and going. But the benefits of spending a little time each week keeping up with your books and keeping your business finances separate year-round can certainly save you time during tax season. More importantly, it can also save you from accidentally claiming a deduction that you shouldn’t have taken.
Mingling your personal spending with your business operations can lead to mistakes, like claiming deductions you didn’t deserve or claiming a higher amount of business expenses than you actually had. If you are sloppy about your deductions, this can lead to higher scrutiny from the IRS…or even an IRS tax audit, which can result in additional fees or fines depending on the nature of the oversight.
Another consequence of not separating your personal and business funds could come in the form of a lawsuit directed toward your company. Your business is supposed to exist as a separate legal entity, which helps protect your personal assets from lawsuits against your company. But if you are combining your business and personal finances, this weakens your case for being considered “separate” from your business. By clouding that issue, you could open you up to significant risks.
In the event of a lawsuit and a judgment against your business, creditors might argue that you and your business are one and the same, since you share a bank account and pass funds back and forth fluidly. By trying to “save money” mixing your business and personal finances, you might end up being personally liable for a devastating judgment in a lawsuit. Don’t take that risk!
Simple Ways to Keep Business and Personal Finances Separate
Your first step in keeping responsible separation between your personal and business funds is opening a business checking account. Start by asking your current bank (where you have your personal accounts) to see if they offer any special deals or benefits to customers who open business accounts. That said, don’t be afraid to shop around. Lots of banks will compete to get you to open an account with them; you might be able to negotiate more favorable interest rates, lower fees or a larger business line of credit. Just do your homework on their offerings, and don’t shy away from discussing your business banking needs. It may take additional time, but getting the right business banking relationship set up can help your business save (and make) a lot more money in the future.
You should also use simple accounting software to keep track of your business finances, including your business expenses. There are a lot of great online accounting software tools for small businesses that have become more user-friendly over the past several years, so do some research and see which tools are the right fit for your business.
If you already have an accountant, ask them for recommendations about the best way to track your expenses throughout the year to get ready for tax season — they should be happy to have some help in making their job easier! Make sure that any accounting software you choose can connect with your business checking account, business credit card, and any other business accounts, which can simplify the process of reconciling all your transactions in one place.
Additional Benefits of Separating Your Business Finances
There are many other benefits of creating a clear separation between your personal and business finances. For example, it can be much easier to build your business credit score and borrow money in your company’s name if you can prove your business is a separate legal and financial entity, and that it has a track record of financial stability under its own name. In many cases, lenders want to know that your business is sustainable and growing without the help of personal funds from the business owner. Keeping your business finances separate helps show lenders that your company is “for real,” and that they are likely to get repaid for any money your company borrows.
Separating business finances from your personal funds can also have psychological benefits. It will help you feel calmer when looking at your company’s financial state, knowing that your books are clean and you don’t have any personal expenses muddling the situation. You can also feel more confident filing your taxes knowing that your business expenses are legitimate and you’re not missing out on any valid deductions.
Also, when you want to review your finances with a potential outside investor or prospective business partner, you want to look as professional as possible when pitching your business. Investors might get wary if they reviewed your financials and saw you had a habit of swapping money back and forth between your personal and business accounts. This could give them the false impression that you operate haphazardly, which doesn’t exactly boost the confidence of savvy investors.
In a technology-driven world filled with apps and other helpful ways to manage your business, you can easily create your own ways of separating your personal and business finances. This doesn’t mean you can’t invest your own funds or reimburse yourself for owner contributions; you just need to do it appropriately, in a way that makes sense for your business and has the approval of your accountant.
Are you ready to start a business, form an LLC, or reorganize your business structure to get serious about operating as a “real” legal business entity? Talk to Incfile today! Our incorporation experts can help you evaluate your options and get on the right track for a brighter financial future — both business and personal.
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