When you first start your business, it can feel like your company is an extension of yourself. It’s easy to let your personal and business finances mix together, especially if you’re not making a profit from your business (yet!). However, it’s critical to establish a clear line between your personal and business finances early on.
Below we’ll look at why creating that distinction is so important and what you can do to clearly separate the two.
1. Personal Banking Accounts Don’t Support Your Business Needs
One of your first moves when starting a company should be to establish a separate business bank account for your funds. By setting up a separate account, you’re not only creating a clear paper trail dividing your personal and business finances, you’re also opening an account that will help you run your business. Business accounts come with features that allow you to process credit card payments through the bank’s merchant account services, accept ACH or wire transfer payments, and manage your payroll.
2. Personal Credit Cards Make Tracking Expenses a Challenge
One of the perks of having a small business is getting to write off expenses associated with that business at tax time. But if all of your expenses—from dog food to printer ink—are going on the same credit card, it’s harder to separate your personal expenses from the business-related charges. Save yourself from trying to divvy up these expenses after the fact by opening a business credit card. Lots of business cards have features like the ability to add employee cards and receive detailed monthly or quarterly reports that give you insight into your business’s expenses.
3. Accurate Bookkeeping Becomes a Nightmare
When using bookkeeping software, you need to enter all transactions in order to reconcile your accounts. But if some of the transactions are for personal needs, they’re muddying the financial records of your company and hindering your ability to clearly see your company’s income. When you attempt to leave personal transactions out of the software, you can’t reconcile the accounts. This is yet another reason why the business bank account and credit card are crucial.
4. Tax Preparation is More Difficult
Tax season is already a challenging time, so why make it worse by mixing your finances? If business and personal funds are combined, your CPA is faced with the difficult task of disentangling your personal transactions from your business’s income and expenses. With all of the money combined in one place, it makes it difficult to determine your company’s actual revenue, and it makes separating out business expenses for deductions a real challenge.
5. If You’re Audited, You’re In Trouble
The IRS looks for red flags like business-related deductions as a factor in determining who to audit, so small business owners need to keep meticulous financial records. If you do get audited, the burden of proof lies squarely with you—you need to show that you’re not using your business’s funds for personal expenses and that any deductions you claimed are 100% business-related. And if the IRS finds you’ve fudged on your taxes, there can be hefty fines coming your way. Having separate bank accounts, holding onto receipts, and checking out the IRS’s guidelines for business deductions can help you emerge from an audit unscathed.
6. You Need Personal Protection
If the financial line between yourself and your business isn’t clear, it can leave your personal finances and assets vulnerable if your company is ever sued. Establishing an LLC or S-Corp can help protect your personal funds and home should your business find itself in a sticky legal situation. Talk with your attorney, CPA, and financial advisors to determine which type of entity makes the most sense for your business.
Even if your company is a sole proprietorship, it’s important to establish a clear delineation between your personal and business finances. Not only will it make it easier for you to effectively run your business and track your income and expenses for yourself, but it will save your CPA from unnecessary headaches at tax time and in the case of an audit.