Why It’s Important to Separate Business and Personal Finances

408
Why It’s Important to Separate Business and Personal Finances

When you start a small business, it’s easy to put the separation of your finances on the backburner. You may figure your business isn’t big enough to worry about it, but situations can come at you fast.

For example, if you made a product or delivered a service, and it ended up hurting someone, what would happen?

Someone could file a personal injury claim against you. While your insurance would likely cover the claim, it can still be important to have your business and personal finances fully separated to simplify the situation.

The following are key things to know about the separation of your finances and assets as a business owner.

Personal Asset Exposure

When you start a business, one of the first things to do is create a legal structure. That will then protect your personal assets.

You might opt to set up your business as a limited liability company (LLC) or perhaps a corporation.

The structure of your business determines your liability, tax responsibility, and your risk.

However, even if you have certain legal protections in place, if a client brings legal action against you and the court can’t determine the distinction between your personal and business finances, you may be personally liable for business debts. That’s why, in addition to properly structuring your business, you need to separate your finances.

If you don’t separate your finances, then the court can make your personal assets fair game for seizure, meaning creditors can go after your personal bank account, your home, or your other assets to cover business debts.

Set Up a Business Bank Account

One of the easiest things to do to start separating your finances is to create a separate business bank account that you never use for personal expenses. You shouldn’t deposit checks made out to your business into your personal account either.

This, in and of itself, provides you a great deal of protection.

All business assets should be titled in your business’s name, as should loans and liabilities for the business.

If you transfer money to yourself as the business owner, it should be done following protocols like salary.

Claims from Lawsuits and Creditors

When you form an LLC or a corporation, you’re limiting liabilities that come from your business to the capital you have invested.

A creditor, when filing a claim against your business, will in most cases not be able to make a claim against you personally.

Proof of Financial Stability

When you own a business, there are times when you need to see and perhaps show the financial status of your business. If you have your records separate, this becomes a lot easier.

You might have to show financial statements to a bank or maybe a possible business partner. You want to be able to do so quickly and accurately, so if you set things up separately from the start, this will be possible.

There’s the concept of leverage to consider here. Leverage means that you use borrowed funds for investments, and you hope that your payoff will be greater than the interest you pay. If you’re using leverage in your personal finances, there’s a big risk. You’re putting your own assets on the line.

In business, the use of leverage is common. You can make smaller investments in your business with the goal of greater future profitability.

Since there is a risk to the use of leverage, making specific distinctions between personal and business finances is important.

Taxes

If you have commingled personal and business finances, it can mean you face tax trouble.

The IRS does let you deduct business expenses, but if you purchase those with your personal account, your accountant will have to verify them. Then, you’ll end up paying your accountant more.

If your business gets audited, they’ll have to verify the expenses you claim.

If you don’t have your finances separate, they may audit your business and personal financial records. It will be more difficult to validate legitimate expenses.

Finally, having separate finances will help portray your business as reputable and professional.

You don’t want people to see your business as a hobby, and if you don’t have a business account, that’s going to erode your image. You certainly don’t want investors or clients writing checks to you personally.

If you’re a business owner and you haven’t done so already, start separating your finances sooner rather than later for protection and professionalism.