Why Your Personal and Business Expenses Must Be Separate
Anyone who has founded a small business will tell you: It’s easy to commingle your personal and business finances, especially in the earliest stages of owning your own company.
But it’s imperative that you don’t.
You might be enticed to write a personal check for work equipment, or accidentally use your business credit card to pay a personal bill. But doing so can lead to serious operational, financial and even legal challenges.
Read on as we discuss why it’s essential to keep your personal and business expenses separate, and how doing so can protect your business, improve financial management and even save you money in the long run.
5 Reasons Why You Should Keep Your Expenses Separate
1. Legal Protection and Liability
One of the most compelling reasons to separate business and personal finances is to protect yourself legally.
For instance, business structures such as limited liability companies (LLCs) or corporations are designed to shield personal assets from business liabilities. However, if you mix personal and business expenses, you risk piercing the corporate veil, which means in the event of a lawsuit or financial issue, your personal assets (such as your home, car and savings) could be targeted to satisfy business debts.
2. Easier Accounting and Tax Filing
Separating your personal and business expenses simplifies bookkeeping and tax preparation. When your expenses are clearly categorized, you’ll avoid the hassle of sorting through transactions to determine which are business-related. This clarity makes it easier to:
- Track business expenses accurately for tax deductions
- Prepare financial statements
- Provide necessary documentation if audited by the IRS
3. Compliance With Tax Laws and Regulations
Accurate business records aren’t just helpful — the IRS and other regulatory bodies require companies to maintain them. Thus, if personal and business expenses are intermingled, it becomes harder to substantiate legitimate business deductions. This can lead to:
- Missed tax deductions, resulting in higher tax liabilities
- Potential audits and increased scrutiny from tax authorities
- Penalties and interest charges if expenses are misclassified
By keeping finances separate, you ensure compliance with tax regulations and minimize the risk of costly errors.
4. Establishing Business Credit
Maintaining separate financial accounts helps build a strong business credit profile. A dedicated business bank account and credit card allow your company to establish credit independently of your personal finances. This separation can help your business qualify for loans, secure better financing terms and build credibility with suppliers and investors.
On the other hand, if business expenses are paid with personal accounts, you might struggle to demonstrate your company’s financial health and creditworthiness, making it more challenging to secure financing.
5. Professionalism and Credibility
Maintaining separate financial accounts enhances your business’s credibility with clients, vendors and financial institutions.
A business that operates with its own bank accounts looks professional. A business that operates with the CEO stroking personal checks doesn’t. And an unprofessional image could potentially deter clients and investors.
Best Practices for Keeping Personal and Business Expenses Separate
Now that we’ve covered why separation is crucial, here are some practical steps to maintain financial boundaries between your personal and business expenses:
- Open a business bank account. Establish a dedicated checking account for all business-related transactions.
- Use a business credit card. This helps track expenses efficiently and builds business credit.
- Pay yourself a salary. Rather than withdrawing business funds at random, set up a consistent salary structure.
- Keep detailed records. Maintain receipts, invoices and financial statements for accurate record-keeping.
- Consult an accountant. A financial professional can help you further understand the importance of maintaining the separation and offer guidance on properly delineate the boundaries between your personal and business expenses.
At McManamon & Co., we provide a wide range of accounting services, and helping you understand these financial basics is just the start. We can work closely with you to create financial statements, maintain records and provide expert guidance on financial accounting matters. And once your business grows to the point where you can field your own accounting staff, we can help train them in best practices, as well as the implementation and utilization of accounting software programs.
Make the right money moves for you and your business. Call McManamon at 440.892.8900 or contact us online today.
Tags: accounting, budget, financial literacy, financing, McManamon, McManamon & Co., small business, small business accounting, small business banking, small business finances | Posted in accounting, McManamon & Co., small business, Small business finances