How (and why) to keep your personal and business finances separate
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How (and why) to keep your personal and business finances separate
As a small business owner, every purchase you make is an opportunity to combine your personal and business finances. Some owners don’t want to do this, but feel as though they have to. Others may not give it much thought, or don’t know why it’s important to keep things separate.
There are a number of short- and long-term benefits to you by organizing your business finances and personal books separately, and you should understand those benefits. Let’s take a look.
1. Requirements of business organizations
Some business organizations require you to keep things separate. For example, if you have a small business, you must be familiar with business accounting and avoid mixing it with your personal financial habits. You don’t have the same claim as a sole proprietorship, but you can still choose to follow the same rules. This approach is especially useful if you plan to change your business organization in the future after a period of growth or a similar change in circumstances.
2. Protection audit
You have many deductions and tax credits that you can take advantage of as a small business owner, but you may attract unwanted attention from the IRS in the form of an audit. One of the most common indications for small business owners is claiming home office deductions. If you claim these deductions, the IRS can take a closer look at your tax records and perform an audit.
When you have adequate document separation between your personal and business and financial activities, you can rest easy knowing that you are protecting yourself from potential penalties. If you’re new to filing your small business tax return, ask your CPA or another tax professional to help, to avoid errors.
3. Easier in accounting
Trying to sort through receipts, income, expenses, and assets after they get mixed up takes a lot of time. You have to worry about this quarterly when it’s time to file business taxes, as well as when you want an idea of your revenue and expenses.
You or your accountant have a much easier time when you maintain tight separation in the first place. If you need to look up information about a company’s earnings for a particular month, you can access it within minutes. The tax return process is streamlined and you have better visibility into cash flow.
4. Impact on Credit Score
Your personal and business credit can have a big impact on each other. Some small business owners use their strong personal FICO scores as a way to fund operations or cover expenses. Using your personal credit is one way to open a line of credit without setting up any commercial accounts, but you will be personally responsible for any debt.
If you take out a lot of your personal credit cards and small business loans, and you run into financial trouble, you may have to deal with the consequences for your credit score. For example, with each additional loan, you’ll have an extra “bad” amount on your credit, and those will add up. Your FICO score is affected, which can affect your housing situation, insurance rates, and ability to get more credit in the future.
A common approach that some business owners take is to use personal guarantees for some first line of credit. Once you have established your creditworthiness as a business, you can focus solely on building financing options through your company.
Separate your personal and business finances
Now that you know how important it is to separate your personal and business money matters, it’s time to put systems in place to make this easy. Here are five things you can do to improve your accounting practices.
Get a business bank account.
When you have company money flowing through a dedicated bank account, you limit your chances of getting things mixed up. Your financial institution may also have business credit products.
Follow the plan.
Beware of using business funds only for business expenses and vice versa. You can view your statement to see where your money goes without playing the guessing game of whether it’s a personal or business expense. Receipt tracking software and similar apps can scan your receipts as you make purchases and categorize them for you.
Understand what you are signing up for.
Many business credit accounts require a personal guarantee. Make sure you know what your personal debts will look like and make an informed decision about how much risk you’re willing to take. Your personal credit or financial situation will be an important factor here.
Set salary.
You don’t run the risk of having to use company money to cover personal expenses if you receive a steady paycheck from the business.
Keep detailed records.
Record business use of your personal property. You may have property that you need for personal and business use, such as a vehicle. Record exactly how much money you are using and when you have these records available to your accountant.
In the past, SMBs were largely accepted for funding by major banks and were judged on a single metric: their individual FICO score. Many business owners have been left stumped and may have leveraged their personal credit to achieve their goals. FICO is a powerful tool, but it doesn’t always reflect the overall state of your business. The reliance on it by traditional lenders can cost you a mix of business and personal expenses, even if you don’t want to.
Thankfully, new fintech companies are starting to treat small business owners less like individuals but more like businesses. One way they are doing it is by looking at more data points beyond the FICO score (banking history, invoices and transactions, for example). This allows them to make more comprehensive lending and credit decisions. For business owners looking to grow, online fintech companies offer a solution to this problem, giving you greater control over your business data and financial future.
Fundbox and its affiliates do not provide tax, legal or accounting advice. This document has been prepared for informational purposes only, is not intended to provide, and should not be relied upon as tax, legal or accounting advice. You should consult with tax, legal and accounting advisors before engaging in any transaction.
