Financial Question of The Hour: Why Is It Important to Separate Personal and Business Finances
by Abdul Aziz Mondal Financial Planning Published on: 26 November 2021 Last Updated on: 08 October 2024
Mixing business with pleasure seems like a fun idea as you start your entrepreneurial journey.
Sadly, it is a concoction fr madness and loss. In other words, this is never a good idea, particularly in the long run. This can create a devastating habit that can leave you desperate and confused at the same time. Therefore you must avoid this at all cost.
Given the graveness of the idea, we have decided to address this in our article. In this article, we break down why it’s crucial to separate personal finance from business finance.
Why is it important to keep personal finances separate from business finances?
Your business is an independent entity from you and your assets. Therefore, separating personal finances from your business funds is an important thing to do.
At the same time, doing so safeguards your personal property against business liabilities. You also stand to enjoy tax benefits, more straightforward accounting, and easier access to credit.
Separating business finances from personal finances also helps in compartmentalising. Which in tun, allows businesses to become more professional.
Therefore, it plays a vital role in how your business operates and is perceived. Below is a breakdown of the advantages of separating business and personal finances.
Personal Protection Against Business Liabilities
The most important reason for separating personal finance from business finance is that you get limited liability. This means that your individual property is protected against business liabilities.As a business owner, you’ll often be required to sign guarantees for loans, credit lines, leases, and other business debts.
Should your business fail to pay these debts, your creditors are entitled to claim your cash and assets to recover their money IF you mix business and personal finances.
The best way to ensure personal security is to separate personal finance from business finance.
Tax Benefits
The IRS offers small business tax deductions for qualifying expenses, including employee salaries, benefits, interest expense, etc. However, to be eligible for these deductions, you must prove that the costs were purely business and not personal. This tends to be hard to show when you mix personal and business finances.
You can use that account’s transactions as proof of eligibility for tax deductions. Besides, having a business checking account makes it easy to accurately record business expenses. This always comes in handy, not just for claiming tax deductions but also for filing accurate taxes. Otherwise, you may find you and your business in trouble with the IRS.
Want to know how to take advantage of small business deductibles and reduce your tax burden? Check out this list of top deductible small business expenses for 2021 and beyond.
Simplified Bookkeeping and Accounting
Proper bookkeeping can help you maintain a positive cash flow . It’s, however, hard to get your company’s accounting right when your business and personal finances are mixed. You’ll first need to sort through a mix of individual and business transactions to pinpoint the ones that relate to the company.
This is not only unnecessarily tedious, but it also increases the risk of inaccuracy and human error. The better bet is separating business finance from personal finance. That way, you’ll have all your business transactions in one place, which makes bookkeeping and accounting easier.
Easier Access to Credit
Most financial institutions will require you to prove that your business generates income before they extend loans and credit facilities. Blending your personal and business finances doesn’t entirely paint the picture that a lender wants to see in assessing the business’s profitability. This, in turn, can be a deal-breaker regarding their willingness to give your business access credit.
The better alternative would be to qualify with your credit and leave the business account as it is. The lender will use your personal credit score and business income to underwrite your loan application.
Creates Professional Image
A significant yet overlooked advantage of separating personal finance from business finance is that it makes your company appear more professional.
Customers, debtors, lenders, and other parties find it fishy when you give them your details for business payments. To create a professional look for the business, it’s always wise to open its checking account and use it for all business transactions.
How Do You Separate Personal Finances from Business Finances?
Opening a dedicated business checking account is the easiest way to separate personal finance from business finance. In doing so, you’ll have achieved two things.
First, there will be a clear distinction between personal and business finances. Secondly, all your business transactions will go through the said checking account. This doesn’t just simplify bookkeeping, accounting, and tax filing, but it also entitles you to tax deductions. It proves to the IRS that your company is a business, not a hobby or side hustle. Otherwise, you would be ineligible for tax deductions.
Alongside opening a dedicated checking account for your business, here are other ways of separating personal finance from business finance:
1. Consider Incorporating the Business
Your company’s legal structure determines whether you may mix personal and business finances. No laws prevent you from mixing your finances with your company’s if it’s a sole proprietorship. However, you’re legally required to distinguish company finance from yours in the case of a limited liability company (LLC), C Corp, and S Corp.
2. Keep Receipts Separate
In addition to incorporating the business and opening a dedicated checking account, consider distinguishing company receipts from personal receipts. This will ensure that business-related transactions are neatly stored away from individual transactions. When filing taxes or claiming deductibles, you can easily prove your business expenses and income.
3. Get a Business Credit Card
Should you need an additional account to your business checking account, consider applying for a business credit card. It will help you make business purchases without using your credit card. In doing so, the business credit card will ensure that you keep business transactions (and finances) separate from personal ones. It’s also an excellent tool for building business credit and earning travel rewards.
4. Pay Yourself a Salary
Not paying yourself a salary is an excellent way to save on business expenses. Unfortunately, doing so comes with some drawbacks. For one, you’ll be tempted to pull money from the business for personal use haphazardly. This greys out the line between business and personal finances. But if you pay yourself a salary, there won’t be any need for that.
5. Apply for an EIN
Short for an employer identification number, a business EIN is a unique number that identifies your business. Think of it as a social security number but for businesses. When you have an EIN, you may use it to file taxes, open business accounts, apply for business credit cards, etc.
In doing so, you won’t have to use your social security number for such tasks. This, in turn, further separates your finance (and business activities) from those of your company.
6. Engage a Certified Accountant
While not the best option, especially for a small business with limited finances, working with a certified accountant can help separate personal finance from business finance. If individual and business activities are already entangled, an accountant may help you distinguish them.
They can also set up long-term systems to ensure you don’t mix personal and business finances. This doesn’t just make your accounting work more accessible, but it also legally protects the business’s status as an entity.
Save More with Nearside
Separating personal finance from business finance is excellent because it entitles your business to tax deductions. These can save you a lot of costs. Pair that with an affordable checking account for business, and your company will have more money to reinvest in growth.
Need a modern checking account that’s designed for businesses? Sign up for Nearside today and enjoy cashback, perks, discounts, and rewards on essential financial and management services. We do not charge any NSF fees or monthly maintenance fees. Nearside doesn’t have any minimum deposit requirements either.
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