Don’t Mix the Personal and the Business; Keeping Finances Separate
When you launched your business you might not have paid much attention to keeping your personal and business finances separate. If a vendor needed to be paid you grabbed the closest checkbook and wrote out a check, even if it was a personal account. It’s not a big deal since it’s all yours, right?
Wrong. Keeping personal and business finances separate is actually quite important. Here are the reasons why it matters, tips on keeping finances separate, and what to do if you’ve comingled funds in the past.
Be Ready for Tax Season
If you use the same checking account to pay both personal bills, such as your mortgage, and business expenses such as rent, you’re making it harder on yourself come tax season. If your expenses are combined, you would have to go through each bank or credit card statement line by line to identify which expenses can be deducted and which were personal.
This also could raise some confusion about whether or not you’re operating a separate business which allows you to take deductions. The IRS will only let you claim a business loss for three years before classifying it as a hobby. If you’ve yet to break even and aren’t keeping separate accounts and records you’ll have a harder time arguing for business status with the IRS.
Keeping finances separate ensures that you don’t miss out on any tax deductions.
Saves you Time
Keeping your finances separate not only helps you be prepared for tax season, it saves you time. It will be easier to match receipts to bank statements to have support for your accountant, and preparing your taxes will take them less time.
Entering transactions into whatever accounting system you use and reconciling your bank accounts will also be a quick process. You won’t have to take the time to exclude certain charges or classify them as personal. If you use a business credit card, the interest is tax deductible. But if you’ve charged personal expenses to the card you’ll have to break out the interest.
Builds Business Credit
One of the ways to build a business’s credit is to have business checking and savings accounts. There are many benefits to building business credit separate from your personal credit, particularly if you have poor personal credit.
The three main credit bureaus track a business’s credit based on your credit obligations, legal filings, and details on your company’s background. Similar to a personal score, details such as your credit utilization ratio, late payments, and balances are used to calculate your score. But because it’s separate from your personal information you could build a business credit score that’s higher than your own score.
Keeping accounts dedicated solely to your business, paying bills on time, and avoiding overdrafts, builds your business’s credit. A high business credit score can help you access capital when you might need it to grow your business and receive better interest rates on loans.
Track your Profitability
When you mix your finances it can become hard to track your business’ profitability. Just because there’s money left in the bank account at the end of month doesn’t mean that you’re making money, especially if you’re mixing finances. A side job, or a spouse’s job, could be keeping your business afloat. Or, cash flow timing could obscure business losses.
If you keep your finances separate, you’ll have a better grasp on your business’s profitability. Negative balances or overdrafts in the business account can help you identify cash flow issues. Preparing a profit and loss statement will take less time, or your accounting software could generate it automatically, if all the information needed is in the same place.
If you pay yourself a salary from your business account, rather than just lump all income into one account and pay all expenses out of it, you’ll have a clearer picture of your business’s ability to support you as an employee. And it’ll force you to stick to a personal budget rather than just pulling cash from the business when needed.
Tips on How to Keep Finances Separate
The easiest way to keep finances separate is to have separate banking accounts and credit cards. Always use your business checking account to pay business-related expenses. Leave the checkbook at your office or in your desk so you’re not tempted to use it for personal expenses when out and about.
When depositing payments from customers, always use your business checking account. This makes bookkeeping easier but also avoids giving the appearance to the IRS that you’re trying to hide funds. If you do need to withdraw funds for personal use, keep clear records of any transfers within accounts.
Should any employees have business credit cards or access to business accounts make sure that they, too, are educated on using them properly. Stress the importance of keeping receipts and, should they accidentally use the account for a personal use, of letting your bookkeeper know immediately. You could try supplying them with prepaid business debit cards, instead, but they will still need to keep receipts.
If it does become necessary to inject your business with personal funds, treat the deposit as a loan. Set up a payment plan to pay the money back to your personal account, and record it on the books as a business loan. Alternately, you can call it an owner’s equity investment. Try to avoid depositing personal funds into the business randomly.
Setting up a budget for your business will help you avoid needing to make random deposits into the business. Sticking to it aids with tracking income and expenses and avoids blurring the lines between the personal and professional. It also helps you track your net profits.
Taking the time to separate out your finances saves you from hassles down the road. Establishing clear bookkeeping practices and standards supports your business’s legitimacy in case of audit.
Fixing Past Mistakes
What if you haven’t been great about not mixing your personal and business finances? Plan on taking some time to clean things up.
Print out all bank and credit card statements and comb through them. Identify each transaction as either personal or business-related. Be careful around expenses that the IRS are known to scrutinize, such as; dining out, hotels and travel, entertainment, clothes and cosmetics, and any personal rent or car payments.
Classify all transactions correctly and break them out for your accountant. There are numerous ways to handle the personal expenses you put through the business. You can take them as a fringe benefit in addition to payroll or you can rebook them as a loan to shareholder. If you have any questions about what’s an allowable deduction or the best way to book expenses, consult with your tax professional.
In conclusion, taking the time to avoid comingling funds will help you run your business more efficiently and successfully, saving you time and headaches in the future.