It’s not uncommon for entrepreneurs and small business owners to use their personal bank account to patch their business expenses, especially during the beginning of their endeavor and in the time of crisis. And especially if the entrepreneurs in question are women, who notoriously and unfairly have a harder time acquiring capital for their business ventures.
This opens the door to a habit of constantly using personal money to finance business expenses. While writing a check from your bank account seems like an easy and reasonable thing to do in moments of need, it’s definitely not a clever business practice to follow. On the contrary, it is a habit that can cause many problems, particularly if you are planning on growing your business. Here are some viable reasons why you should keep your business and personal finances separate, and how to do it.
Business liability should stay a matter of business
One of the crucial arguments for keeping business and personal finances separate is that you are held personally responsible for the debts of your company if you decide to ignore this advice. This means that if you have a company crisis, you will not need to cover your debts from personal assets – a gargantuan bump on the road that has caused many business owners to lose a lot of money, and sometimes even their only homes.
Because of that, many small business owners opt for forming a limited liability corporation (LLC) as their chosen business format. By choosing LLC, entrepreneurs avoid the risk of being held liable for the debts of their business. The main difference between a sole proprietorship and an LLC is that sole proprietors can be unlimitedly liable for lawsuits, business debts, and other financial obligations, while LLC owners are burdened only with limited liability.
This doesn’t keep you completely safe, though. If you mix your money with corporate assets, a judge might find you responsible for “piercing the corporate veil” and rule in favor of the creditors during a bankruptcy process. So, you need to be careful in this case as well.
Business activities should be transparent
One of the biggest reasons to keep business and personal finance separate is that it enables you to have a clear insight into your firm’s activity. You need a dedicated business bank account as the address of incoming receipts and the source of your business payments. This creates an ongoing record of all your business activities. Consequently, it will be simpler to prepare financial statements, monitor your profitability, and file a tax return.
Additionally, a separate bank account will prevent unintended expenses. No matter how responsible you are, there’s always a risk of spending more money than you have intended on your expenses and leaving your business short on finance.
A separate bank account and separate finance, in general, can help in securing different ways of business financing, including equity financing, debt financing, and secured loans.
Securing tax benefits
The first person who will be thankful for keeping the two aspects of your finance separate is your accountant, because it will make filing for tax returns far easier. When the two are not detached, the accountant has to untangle the funds before filing, which may cost you extra money.
Additionally, having your personal and business money on the same account may result in losing tax deductions for some of the corporate expenses paid from your personal account. It’s possible that you forget to count in all the business expenses when filing for a tax deduction, and end up paying much more than you should in taxes.
Furthermore, if your company is ever audited by the IRS, keeping everything neat with two separate accounts will provide you with a clear record of income and deductions to show them.
Prevent identity theft and make transactions easier
According to this MoneyTips survey, more than 60% of respondents have had their wallets lost or stolen, and more than 20% have lost their wallet twice. Many of us carry our credit cards in our wallets, which, in case of robbery, makes us vulnerable to identity theft.
When you have all your funds on one credit card, including the ones from your business, identity theft can be even more tragic, as your business information can be compromised. The best way to prevent this is to have a credit card that’s in the name of your business so that potential perpetrators will be unable to access your personal information.
Also, a business credit card is useful when you have to engage in a large number of routine transactions.
However, if your business is still not sufficiently established to get a business card, the second-best solution is getting another personal credit card that will be used exclusively for business purposes.
Preventing the physical chaos
Up until now, we have discussed only the abstract aspect of separating finances, but what about the files, accounts, and documents regarding business and personal accounts? Getting them all tangled up can result in not having a clear overview of business activities or even losing some important documents. Physical separation is simple if you have an office, but if you work from home, things get slightly more complicated.
Depending on the space you have in your home, you can create a full-blown home office in a dedicated room or design a workspace nook in your living room.
Also, since we are living in the digital age, it’s important to have a computer filing system that prevents your personal documents from interfering with the business ones. It would be best to have a storage space specifically designed for all the corporate files.
Don’t take the business (stress) home with you
As an entrepreneur, you have an obligation not only to your work but also to yourself and your family. Money that is taken from your account to cover business expenses is the money you would otherwise use for household or personal necessities. Juggling between the two will only add to the emotional rollercoaster of running a business. Marrying personal and business finance means you are tying the knot on the anxiety of the business world and the simple problems of living your life.
Understandably, you observe your business as a part of yourself – but as a business owner, you need to distance yourself and make sure one missed sale doesn’t affect your ability to pay the electricity bill at home.
Now that you understand all the reasons why you should have a clear distinction of personal and corporate finances, why not go through these tips one more time and see what you can do to improve both aspects of your life?