Blurring the lines between business and leisure is never a good idea. The need to separate personal and business finances is imperative when starting a business, as it will not only play a significant role in how your business operates, but how it’s perceived by the corporate world. Differentiating between personal and business finances can provide an array of benefits, including tax advantages and the ability to shield your personal assets. However, if left undone, it can also leave you high and dry when things go awry.
Separating Your Personal & Business Finances
As a first-time business owner, it’s crucial to remember that your company is an independent entity; it’s free-standing from you and your personal finances. Although it may seem apparent, there are many reasons why business-owners need to separate their personal and business finances. The following breaks down the most important reasons why you should consider doing so yourself:
Your Professional Image
The importance of separating your personal and business finances also comes down to your professional image. Your business is more than a hobby, therefore your finances should be treated as such. Having two separate accounts rather than using the same for both business and private purposes makes you look more serious, including helping to establish your business identity. Investors should apply for credit cards and checks in their business name, which will help to draw a clear line between personal and business expenses. At the end of the day, you want people to take you and your business seriously. Having them write a check to you personally, rather than the business, will come off as amateur.
One of the major reasons to separate your personal and business finances is for tax purposes. The ability to take advantage of tax deductions, including writing off business expenses, is a huge reason many business owners choose to split their personal and business finances. Keeping accurate records of personal and business expenses is vital when running a business, as this will not only help save time but a significant amount of stress as well. Keeping good books of expenditures can also assist in the event of an IRS audit. If your finances are merged, this will more than likely result in the IRS auditing both your business and your personal records.
Another important reason to detach your personal and business finances is business credit. The ability to obtain working capital for your business is vital to grow it, and business credit will be mandatory to secure larger business loans. Having your personal and business income blended together makes it more difficult to provide your business income to banking agencies, therefore making it more difficult to establish your business credit.
Generally speaking, a business owner’s personal credit will be assessed to determine whether or not to extend credit. Those with a strong credit score will ultimately have more borrowing power, but bad credit isn’t a deal breaker. In most cases, the borrower will be required to sign a guarantee in their personal name to secure the loan. But this also means you are personally responsible for any debt incurred by the business if it defaults.
Save Time And Money
The importance of separating personal and business finances really comes down to saving time. Hiring an accountant will come with a cost, but having complete separation of finances equates into less billable hours, helping to save you a large amount of cash in the process. Purchasing business accounting software is another option, as this will provide investors with options and guidance in maintaining their financial records.
Tips For Keeping Your Personal & Business Finances Apart
Now that we understand the importance of dividing between personal and business finances, it’s time to go ahead and get started.
Maintain Separate Accounts: The ability to distinguish between personal and business finances is critically important. Creating an individual account for your business will help to tell the difference between personal and business expenses, as well as assist your case if the IRS ever questions the legitimacy of your business. Having separate accounts also doesn’t hurt the credibility for your business identity.
Determine How To Structure Your Business: Establishing a legal structure for your business is far and away the most important step you can take in separating your finances. Whether sole proprietor, corporation or forming a real estate LLC, the legal structure of your business will basically dictate everything from your risk and liability, to how the IRS will retrieve your business taxes.
In order to make the best decision, take the time to discuss your options with an attorney, CPA, and financial planner. Depending on the corporate setup of your business, you can, in fact, be held personally responsible for company debts, including seizing assets to satisfy creditors. The best way to disentangle yourself from personal and business debts is to form a limited liability company (LLC). This hybrid type of business structure provides legal protection, enhanced creditability and pass-through taxes.
Pay Yourself A Salary: Another tip for keeping personal and business finances separated is by paying yourself. Dishing out a salary can help business owners isolate the line between business and personal profits, instead of haphazardly pulling money from their business. Providing yourself with a regular paycheck will not only better the chances of your business succeeding, but keeping you on your personal budget.
Track Shared Expenses: The best way to steer clear from being audited is to track shared expenses. Separating receipts for your business expenses is vitally important when running a business, as co-mingling has the potential for dire tax consequences — which no one wants. The most efficient way to track expenses is to use separate credit cards. For business expenditures use your business credit card, while personal expenses should be taken care of through your personal finances.
Dividing personal and business finances is the first step to transforming an idea into reality. Once your company becomes a registered entity, your idea of owning a business becomes reality — and separating finances will help to ensure it succeeds.