Chances are you probably work odd hours and are used to paying for business expenses out of pocket (at least in the beginning). When you think about your month’s expenses, you most likely think about all your expenses… including mortgage or rent, car payments, school loans, groceries and then any other business expenses.
However, as your business grows, it’s important to keep your personal and business finances separate. In this post, we’ll discuss the key reasons why it’s so important for small business owners to maintain this sharp distinction and offer some tips on how to do it.
If you have been running a small business or freelancing for a number of years, you know how hard it can be to track down all your business income and legitimate business expenses when it’s tax time.
This task is exponentially harder when you’ve been using one checking account for your groceries, home and office expenses. Maybe you have to dig through receipts to find one that might include a purchase for office stationary, or check each month’s credit card statement and figure out which furniture purchase was for your living room and which was the new desk for your office.
Keeping separate bank and credit card accounts keeps everything organized. When it’s time to file your returns, it will be easy for you or your accountant to clearly identify all business income and expenses.
Separate business accounts won’t just facilitate your tax filing, they’ll also prove useful should the IRS ever audit your business. As certified financial planner Richard Salmen explained, “If there’s ever a question as to whether it’s a hobby or a business, the IRS looks to see if you have a separate checking account.”
When your business expenses are mixed with your personal monthly expenses, it’s hard challenging to see a clear picture of your business’ finances.
Separating your finances can go a long way to better understand how much you’re spending on your business, what you’re spending it on and, most importantly, where you could cut back.
Most small business owners typically rely on their personal credit and assets to fund their business. The reason is simple: Banks won’t even think about granting a loan or credit to any person or entity that doesn’t have a credit history. When you open a business bank account and credit card, you’re taking a very important step toward building your business’ credit profile.
Using a business credit card wisely will help increase your business credit card limit. This, in turn, can help your business boost its borrowing power and get bigger business loans with lower rates down the road.
What’s more, a business credit card won’t always impact your personal credit score and, in some cases, the interest paid on a business credit card is deductible as a business expense.
If you formed a corporation or LLC for your business, then you’ll need to keep your business and personal finances separate in order to stay on the right side of the law.
Here’s why: A corporation or LLC is considered a separate legal entity from the business owners. It’s this separation that may have compelled you to incorporate or form an LLC in the first place, as it helps minimize a business owner’s personal liability.
But since the corporation/LLC is a separate legal entity, it needs its own bank account, tax identifier number, etc. In fact, should your business ever be sued, the plaintiff may try to show that you’ve mixed your personal and business finances, thus try to come after your personal assets.
In short, if your business is structured as an LLC or Corporation, it’s imperative that you separate your business and personal finances. And, it’s still a smart idea for sole proprietorships (for the first four reasons).
Once you recognize the significance, you might be wondering how exactly you should separate your business and personal finances:
You’ll most likely need a tax identifier number in order to do this, and sometimes your business formation documents. There are tons of free checking accounts out there. You may want to open a business account where you already have a personal account in order to facilitate transfers between the two. Just be sure to understand all the fees, minimum balance requirements, and other fine print for the account.
Protect it as you would your personal card and use it wisely!
Put all your business expenses on the business credit card or checking account. If you’re accustomed to throwing all your purchases together, this can be a hard habit to break. Just remember that you’re a business owner, not just a freelancer, and you need to treat your work as a business.