It doesn’t matter if you’re just starting out as a small business owner or you’ve been doing it for a while now — we all know mixing business with pleasure can be a slippery slope.
Some businesses, such as LLCs and corporations, are required to keep their business and personal finances separate. When you are your business, such as a self-employed sole proprietor, you are not required to separate the two. But it might still be in your best interest to do so!
Keeping your business and personal finances separate can save you countless headaches down the road. Here’s how to get started.
What are business finances?
While it may seem obvious, let’s start by defining this term:
- Business finances: How your business gets funding and spends money.
Your business typically acquires money in one of two ways — by securing business loans or by raising money from investors. Your business expenses are what you spend that money on.
Reasons to separate business and personal finances
Here are some reasons why small business owners, and even self-employed individuals, should separate their finances.
- Tax reasons: Separation of your business expenses and personal expenses can save you a ton of time and stress during tax time. This will help you quickly determine what tax write-offs you qualify for and streamline the filing process for you (or your CPA). And if the IRS ever comes knocking with an audit, having separate records of your business expenses to hand over will be a lifesaver.
- Personal liability reasons: Possibly even more important, detaching your personal and business finances helps protect your personal security. Sometimes personal guarantees on business loans are inevitable, especially if you’re a small business newbie without much business credit to speak of. But the less personal liability you have when it comes to your business, the better your personal risk and peace of mind.
- Business credit reasons: Having an established credit history for your business will help you grow your business by proving to lenders that you are a serious and dedicated business owner. A good business credit score will broaden your financing options while protecting your personal assets and personal credit from potential business expenses.
How to separate your personal and business finances
Not sure how to separate your business and personal finances and what best practices to follow? Start with these four simple steps.
1. Decide if you should change your small business structure.
If you’re currently a sole proprietor, ask yourself whether it might be time to establish a separate legal business entity by creating a formal business structure.
If so, you will need to obtain an Employer Identification Number (EIN). An EIN is similar to a Social Security number, and it’s how the IRS will identify your business entity when filling out your business tax return.
2. Create a separate business bank account.
Having your business account separate from your personal accounts will be a huge benefit for keeping track of your business cash flow. A business checking account allows for easy finance tracking and contributes to your business credibility.
3. Get a business credit card.
Now that your business has its own checking account, it’s time to open a credit card for your business. This will be an easy way to keep your business purchases separate, but more importantly, it will also help you start building business credit. If you open a card exclusively for your business, you may even be able to write off any associated annual card fees or interest as tax deductions when filing.
3. Determine how you want to pay yourself.
Paying yourself a set salary can help you draw a clear line between business profits and personal profits. It can also help you stick to a budget, improving your chance of success. Whatever method you chose, just make sure to keep good records.
4. Practice excellent bookkeeping.
Having a separate checking account and credit card will make this step much easier for you. Keep separate folders (either digital or hard copies) for your personal and business receipts, tax forms, and other essential documents. This will streamline your tax preparation and make it easy for you to track your expenses and stick to your budgets.
If you have any other employees or owners who handle business transactions, make sure they are up to speed on any boundaries between personal and business expenses to eliminate confusion and maximize team efficiency.
Detaching your business and personal finances will help you organize your recordkeeping, streamline your filing during tax season, build business credit, and provide much-needed personal legal protections.