Entrepreneurs often fund the costs of running a business out of their personal bank account – particularly during the startup phase when revenues might not be high enough to meet current business expenses and debt obligations.
Writing a check from your personal account may be the easy thing to do, especially when a vendor arrives demanding payment for goods or services you bought. But it’s not a good business practice to follow, especially if you want to grow your company. There are several reasons why small business owners should set up a business bank account, open a business credit card, and keep their business and personal finances separate from the beginning.
Business Liability Should Stay with the Business
The biggest reason why you should try to stop charging business expenses to your personal credit card is the most obvious – when you pay for something from your personal account you have the responsibility to pay for it!
Many small business owners choose to form a limited liability corporation (LLC) for this reason when undertaking a new venture. Why is an LLC important? By choosing an LLC as the business format, a business owner takes an important measure to avoid being held personally liable for the debts of the company. In fact, personal asset protection is the top reason for establishing an LLC.
LLCs are basically a way of protecting business owners. If the company goes belly-up, in most cases you won’t have to pay business debts from your personal assets. The chief difference between an LLC and a sole proprietorship is that sole proprietors risk having unlimited liability for business debts, lawsuits, and other financial obligations. Meanwhile, by definition, forming an LLC provides a business owner with limited liability.
However, if you mix your personal money with your corporate assets, a judge might rule that you have “pierced the corporate veil” and thus find that the business and the owner are one and the same. If a business owner has not demonstrated corporate separation, it is possible that a judge could rule in favor of the business’s creditors during bankruptcy proceedings.
Forming an LLC and keeping personal money separate from business transactions are critical in this regard. Incorporating allows an entrepreneur to operate without worrying about losing his or her home or other personal assets due to obligations the business has to take on. Other benefits of creating an LLC are tax benefits, enhanced credibility when applying for business loans, brand protection, and perpetual existence.
Corporate Taxes Should be Filed Separately
There are certain tax-related benefits of separating your business and personal finances.
At the very least, your accountant will thank you for keeping separate company and personal expenses when it comes time to file your returns. If an accountant has to spend time untangling your funds, he will probably charge extra for the service. Accountants’ rates typically aren’t cheap.
Additionally, a business may use expenses to reduce corporate profits, thus reducing the amount of taxes owed. If you are paying corporate bills from your personal account, these expenses (paid from your personal account) will not likely be considered as a tax deduction. Therefore, you will still be paying (personal income tax) on the amount of the expenses paid from your personal account.
If you must use personal funds to support your business, consider making a deposit from your personal account into the business account (as a loan to the company) and pay the bills from the business account. When there are enough funds in the business account, you can pay the loan back to yourself.
Paying your CPA to disentangle a web of personal expenses from your business account isn’t the only reason it’s better for things to be separate at tax time. The IRS expects business records to be complete and show a clear record of income and deductions. Having separate business accounts and records will prove beneficial if your company is ever audited. The proceedings will be a little more straightforward if the funds are separated.
The easiest and most effective way to make this happen is to have two separate accounts, one for business and one for personal funds. The way to do this would be to open a business checking account right from the start and simply never mingle funds. Think of anything you put into that business checking account from your personal savings as an investment in the business – that’s what the IRS will see it as!
Business Stress Doesn’t Have to Come Home with You
There’s also a practical reason to keep business finances separate from your personal finances. Entrepreneurs have obligations to their families and themselves, as well as their business. Funds that have to be taken from the family coffers to cover urgent business purchases could mean shortfalls when it comes to paying household bills. As an entrepreneur, your day-to-day work can be an emotional rollercoaster all by itself – there’s no need to bring all of that emotional strain back home with you by causing your family to have financial problems. Startup owners often feel the strain that launching a venture can have on personal relationships. Adding financial pressures from co-mingling funds to the mix will only lead to an extra level of stress.
There’s a saying that you should always pay yourself first, but it can get more complicated when you run your own business. A business you’ve started feels like part of you, so it only seems natural to pay for its expenses like you would if it was just a hobby or other favorite personal activity. After all, you might think if you don’t pay for the business how will it ever pay you back? But as a business owner, you have the option to separate yourself a little from your business and choose to keep your personal finances out of the mix. This doesn’t mean you can’t invest in the company when you think it’s worth it. But you’ll feel much better knowing that a bad sales week won’t mean your electric bill at home doesn’t get paid.
Related: Personality Traits You Need to Start a Small Business
No one starts a business anticipating failure. By nature, entrepreneurs are hard-working, optimistic people with a plan for financial success. However, risk is always involved when starting a business. Keeping business funds and personal funds separate and protecting personal assets should be part of the process.