Are you about to launch your own business? Perhaps you recently have, and now you need to get your accounting and finances in order?
We’ve got one crucial piece of advice to start your operation off on the right foot: Separate your personal and business finances!
Delineating between your company and your personal assets early on will significantly impact your success and profitability as well as your professional reputation. Remember that when you establish your business, it is an independent entity. It only makes sense that you would separate the finances.
If you’re wondering when to do it, it’s never too early—but if you haven’t yet, don’t panic, because it’s also never too late. You can put your business in a better position today by separating your business and personal today.
Read on to learn why you need to separate your personal and business finances, plus nine vital steps to do it right today.
Importance of Separating Personal & Business Finances
Bookkeeping & Tax Advantages
Maintaining separate business finances keeps things clean and simple for tax filing purposes. Not to mention, certain LLCs and corporations are required to file separate tax returns and specific documentation.
As an entrepreneur, you’ll certainly want to maximize tax deductions. Tracking all company-related expenses lets you easily write off those that qualify, saving you time and stress come tax season. It will also protect your business in the event that the IRS ever audits it.
Legal & Personal Asset Protection
When you start your own operation, you need a way to distinguish between your business and personal assets to prevent your personal exposure. If your business is sued, your personal finances could be on the line if you lose.
Similarly, if your business goes bankrupt and you don’t have a separately established business entity, it will ruin both your business and personal credit score.
Leverage
Leverage involves using borrowed funds to invest, hoping that the payoff will be larger than the potential interest. Using leverage in personal finance is not ideal, as it puts your personal assets on the line. In business, however, you can use leverage to increase profits in your company. If you do plan to use leverage, you should keep business and personal finances separate.
Professional Brand
You want your company to be taken seriously—after all, your business is not just a hobby! When you establish a business entity, you can apply for credit cards, bank accounts, and checks in your brand name. Stakeholders like investors should write checks to your business, not to you personally, which could affect their perception of your company.
Business Loans
Even if your business is new and you’re not quite ready to apply for a loan yet, the time will come. When it does, you’ll be required to submit both your personal and business tax returns for banks to evaluate your business creditworthiness. And there’s nothing to raise red flags like mixed finances.
When you co-mingle, lenders can’t get a clear picture of important things like your cash flow and revenue. This means they can’t determine your potential to pay back your loan. Sole proprietors have a much harder time getting approved for loans for this reason.
Save Time, Money & Sanity
Hiring an accountant is a significant yet crucial business investment. When you hire a great accountant to help keep your business and personal finances separate from Day 1, you’ll save money in the long run.
If you don’t, you’ll eventually pay a lot more for an accountant’s time to review and clean up your books. Plus, you could be subject to tax penalties if things are missed. Bottom line: You won’t waste time spinning your wheels and stressing over your books and taxes if you hire an accounting professional.
9 Tips for Separating Your Personal & Business Finances
Hire an Accountant
Start by partnering with an experienced accountant to ensure your finances are set up separately and correctly. If you don’t, it can get messy and expensive down the road. Invest in an expert to set up your business for success and mitigate the risks that come with poor bookkeeping.
Establish Your Business Entity
Everything else stems from how you structure your business, which determines your risk, liability, and how you need to file your taxes. You’ll need to choose which type will work best for your organization:
Sole proprietorship
S Corporation
C Corporation
LLC
If you’re unsure what type of entity you should establish, discuss the matter with your accountant, attorney, and financial advisor. They will help determine which is best based on how you plan to operate your business.
An LLC is the most straightforward structure for separating personal and business finances by providing legal protection, enhanced creditworthiness, and pass-through taxes.
Get an Employer Identification Number
Once you establish your business, get an Employer Identification Number (EIN) (basically a social security number for your business). You can easily apply for an EIN online via the IRS.
While sole proprietors don’t need an EIN, it’s a safer alternative to using your social security number. You will use your EIN for essential tasks like filing business taxes and opening bank accounts and credit cards.
Open a Business Bank Account
Now that you’ve obtained an EIN, it’s time to open a business bank account. This step is critical to keeping your business and personal assets truly separate. We recommend starting with a checking account, though many banks offer a savings account at no additional charge.
With a company bank account, you can easily:
Pay bills
Deposit cash
Collect invoice payments
Buy supplies and equipment
...all without the stress and mess of running on a cash-only basis or pulling from your personal bank account.
Open a Business Credit Card
You’ll have business expenses, so you need to have a separate business credit card. Using a dedicated credit card helps you build your business credit score. Similar to your personal credit score, this metric measures your organization’s responsibility with debt, but on a different scale.
Building your business’s credit is essential if you want to grow your company in the future (i.e., expanding your storefront/office, opening more locations, increasing your line of credit, or doing any of the above with financing).
Pay Yourself a Salary
Here’s the fun part: Paying yourself! This step draws an official line between your personal and business finances. Simply pay your salary from your company bank account to your personal account once or twice a month. This ensures you’re not randomly pulling money from your business and helps you stick to your personal budget.
File Receipts Separately
Keep all receipts from your business in a separate file, not piled in with your personal receipts. This is important in case you’re audited by the IRS, which would want to review your receipts. And it’s just another way having a separate bank account and credit card will make your business accounting easier.
Track When You Use Personal Items for Business Purposes
This goes for things like your home office space and equipment, business-related mileage, and using your personal phone to talk to clients—track it all! When you do, you’ll be able to write off qualifying expenses at tax time.
If you’re unsure which items qualify, ask your accountant for tips and advice. Then provide those expense records to your CPA for your tax deductions.
Train Your Team
If you have team members, you need to make sure everyone understands your policies and processes regarding business finances. Train them on the difference between personal and business expenses and create a simple system to ensure organized finances and efficiency. Educating your team is pivotal to reducing accounting and tax headaches.
Are you just getting your new company off the ground and want to make sure you separate your business and personal finances appropriately? Our accounting professionals will be happy to help set you up for success! Contact us or call 603-505-2368 today to learn more.