Here’s Why It’s Crucial to Separate Personal Finance from Business Finance
by Sumona Financial Planning 26 November 2021
As you get your business up and going, you may be tempted to mix business and personal finances. That is never a good idea, particularly in the long run.
In this article, we break down the reasons 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 personal assets. Separating its finances from yours ensures that it is treated as such. At the same time, doing so safeguards your personal property against business liabilities. You also stand to enjoy tax benefits, simpler accounting, and easier access to credit.
At the very least, separating personal finance from business finance gives your company a professional outlook. Therefore, it plays an important role in how your business operates and how it 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 personal 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 forms of business debts. Should your business fail to pay these debts, your creditors are entitled to claim your personal 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 expenses that qualify, including employee salaries, benefits, interest expense etc. However, to be eligible for these deductions, you must prove that the expenses were purely business and not personal. This tends to be a hard thing to show when you mix personal and business finances.
That’s why it’s always recommended to have a dedicated checking account for your business transactions. You can use that account’s transactions as proof of eligibility for tax deductions. Besides, having a business checking account makes it easy to keep an accurate record of business expenses. This always comes in handy, not just for claiming tax deductions, but also for filing accurate taxes. Otherwise, you may find both 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 is one of the best ways to maintain a positive cash flow in a small business. 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 personal and business transactions to pinpoint the ones that relate to the business.
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 quite paint the picture that a lender wants to see as far as assessing the business’s profitability. This, in turn, can be a deal-breaker as far as their willingness to give your business access credit.
Understandably, you may be tempted to pump personal finances into the business account to increase the chances of qualifying for credit. However, the better alternative would be to qualify with your personal 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 highly important 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 tend to find it fishy when you give them your personal details for business payments. To create a professional look for the business, it’s always wise to open its own checking account and use it for all business transactions.
How do you separate personal finances from business finances?
The easiest way to separate personal finance from business finance is by opening a dedicated business checking account. It should be the very first thing you do once your business is registered and licensed – before you make your first sale. 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
The legal structure of your company determines whether you may mix personal and business finances. There are no laws preventing you from mixing your finances with those of your company 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 for it, consider distinguishing company receipts from personal receipts. This will ensure that business-related transactions are neatly stored away from personal transactions. When it’s time to file taxes or claim deductibles, you can easily prove your business expenses and incomes.
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 personal credit card. And in doing so, the business credit card will ensure that you keep business transactions (and finances) separate from personal ones. It’s also a great tool for building business credit and earning travel rewards.
4. Pay yourself a salary
You may think that not paying yourself a salary is a good way to save on business expenses. Unfortunately, doing so comes with some drawbacks. For one, you’ll be tempted to haphazardly pull money from the business for personal use. 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 personal 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 you separate personal finance from business finance. If personal and business activities are already entangled, an accountant may help you distinguish them.
They can also set up long-term systems that will ensure you don’t mix personal finances with business finances. This doesn’t just make your accounting work easier, but it also legally protects the business’s status as an entity.
Save more with Nearside
Separating personal finance from business finance is an excellent financial move 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 the most 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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