Owners of small businesses tend to focus more on the work of the business than the work of the business finances and accounting.
This is natural and acceptable as long as the finance and accounting functions are not overly ignored. That just makes for more work later and can hinder business growth.
Business finances need to be separated from the personal finances of the founder or owner, and the sooner the better — preferably before startup.
A business is an entity in and of itself. It has a purpose, generally including to make money for its owners. Failing to separate business and personal finances can hinder the business and keep it from reaching its potential. Separating doesn’t need to be difficult and it can save the owner time and create value.
Banking and Accounting
The first and perhaps most important step to separating business and personal finances is to use a bank account dedicated to the business.
Generally this should be a checking account. All business income should be deposited into this account and all expenses paid out of this account. This serves as a basis for your business records, as all sources of income and all expenses for the small business are run through this account.
Having a checking account in the business name will be a necessity to process credit card transactions in the business’ name — and consumers love to pay by card.
Whether they choose credit or debit you generally need a business account — rather than a personal account — to take the payments.
The business should obtain, as quickly as reasonably possible, a credit card in the business’ name and at least a small loan in the business’ name. For a small business, the owner typically has to provide a guarantee for these. But it begins the process of building business credit so that the business can ultimately stand without using the owner’s credit to guarantee business debt.
Keeping the business and personal finances separate makes it far easier to substantiate business income and expenses. This will be necessary to obtain business credit.
You will spend less on bookkeeping and accounting if you have good records. If your personal and business records are mixed, you may be spending valuable professional time sorting out what belongs to which side. Make it easier and less expensive by separating expenses from the beginning.
Taxes for You and Your Small Business
Ditto for taxes. If your records are a mixed-up mess, you will either be working late yourself to try to straighten it out or paying someone else to do so. Neither is necessary.
The business checking account is also a key here — as long as you use it properly. You should, as much as possible, run all income and expenses through the account. And when you can’t, then document that well for your tax professional.
Your tax professional won’t deduct expenses they don’t know about. Good documentation saves you money on having your taxes prepared and saves you money by not overpaying your taxes.
It's also important for tracking money that you may have personally paid into the business in its formative stage.
Did you put in money that needs to be recorded as paid in capital? Or perhaps you lent the money to the business and are entitled to earn interest on the loan and ultimately get the principal back tax-free? Aren’t you glad you’re keeping things separate and keeping records so you don’t miss out on these opportunities?
Business Value and Business Valuation
Your business is an asset. You probably want to see that asset grow in value.
We determine the value of a business by conducting a business valuation. There are a variety of ways to value a business; most are valued off of their performance. If you want a higher valuation, you’ll need accurate records — which means they can’t be mixed up with your personal stuff.
There are a few reasons we actually need to do this. As an asset, the business can be collateral for some debt. The higher the valuation, the greater the potential to take on debt, which you may want to do to leverage additional growth.
If you’re not looking to maximize debt, you may get more favorable terms on a smaller amount of debt due to a better valuation.
Some owners look forward to ultimately selling their business. That is a major part of what they are looking to do: grow value then cash out.
A business whose finances are mixed with the owner’s finances won’t be able to sell for its full potential value.
You need clear records to substantiate the price for which you are selling the business. Separating business and personal finances makes your business worth more.
Partition Your Life
Separating your business and personal finances helps provide a partition between your business life and your personal life. You may not want an auditor examining your business to have access to your personal finances because they are commingled.
You could still be audited on personal finances, but there is no reason to invite trouble into the house unnecessarily.
There is a common perception that separating business and personal finances helps protect you personally from liability — the extent of protection it provides tends to be overstated.
There are steps you may want to take to protect yourself; separating business and personal finances can’t hurt from a liability standpoint. But the bigger actions you may want to take are a conversation to have with your attorney.
The Bottom Line
There is no downside to separating business and personal finances. You save time, other than perhaps a couple hours at most to set things up. You save money on your accounting and tax services and don’t end up overpaying your taxes.
Good financial decisions are limited to the quality of the information available.
If your business and personal finances are commingled, you will not have the best information; this will limit your ability to make optimal financial decisions.
Leveraging your business to provide the most for you and your family — that’s the bottom line for many business owners. And separating business and personal finances can improve that bottom line. The place to start is with a business checking account to begin keeping good and separate records.