Why Separating Business and Personal Finances is Good for Business
Let’s say that a few years ago, a self-taught chef named Jimena used her own money to open a store selling her homemade cheese bread.
Thanks to all the bread and cheese fans out there, Jimena’s business has grown. She’s still using the same accounts and credit cards for her personal and business finances, however.
Jimena figures keeping everything together is the easiest way to go because she buys bread and cheese in bulk, some of which she uses for her store and some of which she uses to snack on at home.
What could go wrong?
If you funded the launch of your business yourself or used your personal credit to get a business loan, you’re not alone. It’s fairly common.
But, as your business grows, it’s smart to create a clear boundary between your personal and business finances – and to keep supporting documents that prove your finances are really separate.
This separation can help you better see how much money is coming in from sales and how much you’re spending on your business. That gives you a more accurate idea of your business’ profits, losses, and overall health.
For example, imagine Jimena misreads her combined financial statements and thinks that she’s spending a lot on supplies for her business with not enough sales coming in to make up for these expenses.
She could assume her business is having a rough period or even failing, when actually she’s mistaking several personal expenses she’s made (toiletries, groceries, pet supplies, furniture, etc.) for business expenses.
Another reason to separate your finances is to protect you and your business during tax season.
No matter where you live, it’s safe to assume that the government will be very thorough about making sure people who are selling goods and services are paying enough business tax. And if they’re that careful, you can be, too.
Filing your taxes carefully can be difficult without a separate business account. You have to figure out on your own what was business or personal. And filing taxes wrong can mean paying too much or getting penalized for paying too little.
Also, audits can happen to anyone. That’s when the tax authorities have questions about the taxes you filed. You need to be prepared to show them documents proving what your business versus personal finances are.
For example, the government might think it’s suspicious that Jimena buys so much cheese for her business. It’s up to her to prove her claim that 95% of her cheese purchases are for her business (and 5% for personal snacking).
If Jimena had bought the cheese she needed for her shop using a business account and her cheese for snacking at home on a personal account, she’d have 2 clearly separate documents that could help her prove her claim.
LISTEN UP
If your business fails, banks or lenders might seize your assets (possessions, property, valuables, etc.) to recoup their losses.
If your personal and business finances are tied together, they could take your car, your house, or other personal property.
Now that you know why you should separate your business from your personal finances, let’s look at how you can do it. One way is to incorporate your business.
Incorporating your business basically means making it an approved company in the eyes of the law. This allows you to create a bank account just for your business – and helps you protect your business in the future.
Incorporation can also help customers and the general public view you as a “real” business that has to follow local business laws. They then might see your business as a more trustworthy place to spend their money.
To incorporate your business, find a lawyer that specializes in the type of business you do. It’s a good idea to ask other business owners who they used. Jimena, for example, might ask other food sellers for a referral to a lawyer.
Having a separate bank account for your business is also a great way to separate your finances, particularly for keeping organized records.
You could open a business account with the same bank you have a personal account with, or you could see what else is out there. Do your research. You can start by seeing where other business owners bank. Ask them why.
Then look at each bank’s policies on minimum balance and fees. Remember that most banks want your business so you might be able to negotiate free or discounted services.
Also, know what services you want from the bank before you approach them. Do you want to accept credit card payments? How long will the bank take to process these payments? Do you need the bank to help you pay employees?
Once you know what you want, go into the bank and check things out. Along with getting your questions answered, see how helpful and knowledgeable the staff is, what the online and telephone customer support is like, and so on.
Before opening an account, make sure you’re assigned a point person (not just a 1-800 number to call) who can be available to you to answer specific questions, and who understands your business, its needs, and why it’s unique.
TIP
If your business name is different from your own (for example, The Seven Cheesy Bread Wonders, Inc.) then open the checking account under your business name. Do not open it under your personal name.
Using an accounting system or software can also help you separate your business from your personal finances.
Check out accounting software like QuickBooks, Xero, or Freshbooks that lets you track expenses and digitally sync your business accounts and credit cards. That way, you can see all your business transactions in one place.
Accounting software and systems also let you categorize all your expenses into categories you create, like Production Costs or Marketing Materials, which can be a huge help during tax season.
Don’t rely on your accounting software and systems alone, however. When it comes to filing taxes, it’s a good idea to set up time with a qualified accountant.
DO THIS NOW
Where do you stand when it comes to separating your business from personal finances? Let’s do a quick self-assessment to check.
KEY TAKEAWAYS
Separating your business and personal finances can help you more easily keep track of your business' financial health, file taxes correctly, and protect your personal assets.
Incorporating your business legally makes it a separate entity from you, which can allow you to open a business checking account and protect your business in the future.
Along with incorporating your business and opening a checking account under its name, you can use accounting software or services to track business expenses and work with an accountant during tax season.