We get it — using the same accounts and cards to fund your personal and business life is convenient. But the pros of mixing your personal and business finances come with a bag full of cons as well. It can complicate your financial life, cause more work should the IRS choose to audit you, create a personal liability problem, and fails to help you build your business’s credit profile.
Separating your personal and business finances is something all business owners should do. It allows you to treat your business like the independent entity it is while safeguarding your personal finances. Continue on to find out why this is so important and how you can best separate your personal and business finances.
Why is it important to separate your finances?
Here are three of the main reasons to draw a line between your personal and business finances:
- Taxes: Taxes are confusing. Separate, identifiable business expenses are crucial when it comes to filing taxes, keeping track of receipts, and taking advantage of business tax deductions. Plus, the interest you pay on business financing is usually deductible, which isn’t true for most personal financing like credit cards. Be sure to consult with your tax advisor on your specific situation.
- Protecting yourself: No one starts a business because it’s easy — about 1 in 3 fail in the first two years, according to the Bureau of Labor Statistics. If your business is backed by your personal finances, hard times and late loan or credit card payments can hurt your personal credit score, making personal life harder long after the business is turned around or closed down.
- Boosting your business: it is tempting to use leverage your personal credit score early on because your new business doesn’t have an established credit history. But until you have separate business finances, your business can’t start to build that credit history. Using the personal finance shortcut now delays building your business credit rather than solving it.
Best Practices for Separating Business and Personal Finances
Here are a few additional steps to take to separate your finances and make both your personal and business life easier:
1. Get a business credit card, and put down your personal one. Almost everyone has a personal credit card that creates an easy way to access the funds you need to get your business up and running and cover cash flow gaps. But utilizing a business credit card is one of the easiest ways to get started making a distinction between your finances. Qualifying for a business credit card takes minutes, can give you rewards or other perks, and will protect your personal credit and build your business’s credit.
Plus, using a personal credit card for large business expenses can utilize a large portion of your personal credit card’s credit line, which in turn can bring down your personal credit score. Since debt usage (utilization) is the second most important factor in your credit scores, avoiding high balances can be really important to maintaining strong scores. Maxing out your cards can cause your personal score to drop by 100 points!
Arguably the biggest benefit of opening a business credit card is that you’ll start to build a business credit profile. A strong business credit score boosts your borrowing power and lets you qualify for financing with lower interest rates.
2. Open a business checking account. If you want the separation to be clear, open a checking account strictly for your business. If you’re just as strict about using it (along with your business credit card) for business needs and business needs alone, then getting a clear and complete picture of these expenditures when tax time rolls around becomes a simple matter of reviewing your bank statements.
3. Pay yourself a salary. Make the relationship between your boss (you) and the business official by writing yourself a check each month from your business checking account to your personal. Behave as you would if you were working for someone else. If money gets tight, cut down on personal expenses until the next payday.
4. Establish a legal entity for your business. If you haven’t already, consider establishing a separate legal entity for your business, such as an LLC, C-corp, or S-corp. It would be smart to talk with an attorney or accountant about which structure works best for your business, or use an incorporation service like Inc For Free. You’ll also need to apply for an Employer Identification Number (EIN). By creating a corporate structure, you can protect your personal assets from business debts, losses, and lawsuits. (Pro tip: Nav’s free Business Launcher tool can assist you through what is needed to complete this step.)
5. Keep track of when you use personal items for business use. This includes using your cell phone to speak with customers or using your car to drive across town to meet with a client. These are expenditures that you can legally write off to save you money come tax time. But you’ll need to be diligent about keeping track of how often you are using these items for business vs. personal use. Your tax advisor can help you figure out what’s deductible, what’s not, and how to keep the right records.
Separating your personal and business expenses probably feels like a tedious project to add to your already full plate of things to do. But it doesn’t have to be challenging. Once you have a few systems in place, such as that business credit card, you’ll find that you actually start saving time, and you’ll have completed a step that will be crucial for the growth of your business.
This article was contributed by Nav. Nav provides a free way for business owners to get their personal and business credit reports, as well as tools to help build business credit. Nav’s marketplace saves business owners time by connecting them to credit cards and financing options based on their credit profile.