One of the biggest problems we see with new clients is that their business and personal finances are mixed together. They might pay business bills from their personal checking account or buy groceries with a company credit card. Or they might not even have separate accounts to begin with. This can cause major headaches (and even legal issues) when it comes to managing your books.
In this article, we’ll go over three problems that arise when you don’t separate your finances, and three ways your life is easier if you do.
What Happens if You Don’t Keep Your Personal and Business Finances Separate?
Trouble with Taxes
Tax rates and regulations are often different for individuals and businesses. For example, business owners are allowed to write off expenses for the businesses and can even deduct part of their earnings from their personal income tax. But it’s tough to figure out what amounts to report when your personal and business finances aren’t separate.If you use one account for both business and personal expenses, or go back and forth between two accounts, then tax time will be much more of a headache. You’ll have to go through all your billing statements line by line to find what expenses you can claim for your business and what needs to stay on your personal return. Not only is this process time consuming, it also makes it more likely you’ll miss out on potential deductions or miscalculate what you owe.
Difficulty Getting a Loan
When your business and personal income is combined, it’s difficult to prove you earn a consistent paycheck. The problem with this comes when you need to apply for any type of loan (mortgage, auto loan, small business loan, etc.).The first thing lenders look for when considering your application is proof of income. They need to see a reliable paper trail that indicates how much you earn each month. In fact, they’re so strict with these rules that people who work on commission and don’t earn a steady income need to provide two years’ worth of income proof.
If your finances aren’t separated and organized, it makes it difficult for lenders to determine if you’re a reliable investment, and you’re more likely to be turned down for a loan.
Potential to Lose Personal Assets
Perhaps the worst thing that could happen when you mix business and personal finances is losing your personal assets in a lawsuit. You might choose to use your personal money to fund your business because it isn’t registered as a legal entity, such as an LLC. But this means that if someone wanted to take legal action against you, your savings, income, house, and other personal property would be on the line too because there’s no separation between them and your business.When you register your business as an entity, it’s important to also set up a separate bank account. This account accurately reflects what your business is worth and leaves your personal finances out of it. That way if someone were to start a lawsuit, a court could easily see how much of your assets belong to your business and what personal assets are off limits.
How Life Gets Better When You Separate Personal and Business Finances
Easier to Manage Cash Flow
Separating your finances makes it much easier to see how much money is coming in and out of your business. You can accurately track expenses and revenue to get a quick picture of the health of your business and any areas that might need adjustments.
Having a separate business account also means a single bank statement each month that reviews your cash flow. So you don’t have to worry about going line-by-line through your personal statements anymore and recording what was spent on the business. You can easily file these statements or even connect a software like Quickbooks to your bank account so you always have organized records of your cash flow.
Easier to Plan for Growth
Having accurate financial records at your fingertips isn’t just great for managing short-term operations. It’s also helpful when you’re ready to start planning for growth. Viewing your business’s financial history can help you plot your trajectory and set long-term goals.
For example, if you see that you’re consistently pulling extra revenue, you can invest those profits into new equipment, a new location, or a new staff member, depending on your needs. Or if you notice you’re just scraping by on your regular expenses, you can plan to cut some costs so you stay on track to reach your revenue goals.
More Legal Protection
You don’t want your personal well-being on the line when it comes to trouble with your business. Keeping your personal and business finances separate not only gives you protection in a lawsuit, but it also makes it easier to file accurate tax returns and less likely you’ll end up in trouble with the IRS.
It’s easier to file accurate taxes for your business when you aren’t parsing through your personal income and expenses too. Using bank statements from a single account helps you account for every dollar and cent spent on and made by your business. You’re less likely to miss deductions or miscalculate what you owe.
Finally, when you can prove that your business operates separately from your personal finances, then you have more protection in court. With separate accounts, a judge can clearly see the equity in your business and limit damages to that amount. This protects you from losing your home or life savings in a legal battle.
3 Easy Ways to Keep Personal and Business Finances Separate
Separate Bank Accounts
The easiest way to keep your finances separate is to have more than one bank account. Keep an account for your business that you pay expenses from and deposit revenue into. This is the account that you should pay yourself from also. All of the income in this account should come from business sales.
Your personal bank account is where you can see how much money the business is paying you each month and also where you manage your personal finances. Be sure to pay yourself from the business account consistently, and manage that money just as you would a paycheck from an outside employer.
Separate Credit Cards
Once you have a bank account just for your business, you can use this to get a credit card for the business too (if you need one). You can use this card to make purchases for the business and whatever rewards you might get can go to the business too. This helps you build a credit score for the business so you can make big purchases when necessary without your personal finances affecting the situation.
Be sure never to use your business credit card on personal items. Your personal credit cards should be used for things in your personal life and the business card should only be used for business expenses.
Separate Records
Lastly, you want to make sure you’re keeping separate records. Your business records should be separate from personal bank statements and credit card bills. This helps you better manage cash flow and track growth, as we mentioned in the previous section.
You can use software like Quickbooks, web applications like Wave, or even a simple Excel spreadsheet to keep track of your business revenue and expenses. Upload your receipts for each expense and categorize them as you enter data to help make filing taxes and claiming deductions simple. These tracking methods give you a comprehensive dashboard that explains the health of your business and makes all other financial operations easier.
Partner with an Expert
It never hurts to have an expert on your team, especially in business. If you need help managing your business finances or want some guidance on how to keep them separate from your personal books, reach out to us.
Every Single Bean specializes in helping businesses build better bookkeeping and learn smart financial practices. We’d love to help you get organized and start growing your business.