Most entrepreneurs start a business hoping to fulfill the American dream: becoming your own boss, working hard, and reaping the rewards. One such reward is the money your business will earn. When your business starts to turn a profit, you may be tempted to deposit your business income into your personal bank account. In today’s blog post, we’ll answer the question: “Why is it important to separate personal and business finances?”
When you first open your business, it is likely that you are bootstrapping, and your personal assets are naturally completely entwined with the business. However, pulling your own finances apart from the business is a necessary step towards business success and away from the following financial risks.
Business owners may be audited by the IRS if there are questions or confusion about your financial records. During an audit, you will need to be able to clearly justify all of your business expenses with receipts. If your personal and business finances are entangled, an audit can end up being extremely time consuming and expensive. By keeping your finances separate, you will have financial records that are a lot less likely to be flagged by the IRS for an audit in the first place.
An unfortunate reality is that a large number of small businesses fail. Although it isn’t something you hope for as a business owner, you need to be aware of what will happen in the event of business closure.
All of the debts accrued by the business will become due if your company doesn’t succeed. If your business files for bankruptcy, you may also be required to file for personal chapter 7 bankruptcy (if you are the sole proprietor). Commingled finances in this instance could mean that you will lose your savings, property, and/or home. By keeping your personal and business finances clearly delineated, filing for bankruptcy will not cause you significant personal loss.
Lawsuits can cripple a business in its early years. Whether a suit is over faulty product or an accident that occurred at your business, a lawsuit can lead to years of court proceedings, exorbitant legal fees, and bad press. If you don’t create clear separation between business and personal entities, you can face an even greater financial ruin.
Building business credit
When you first venture out as an entrepreneur, you’ll need to use your personal credit to procure a business loan. Once your business starts to take off, it’s imperative that you separate the two so the business can earn its own credit rating. As your business thrives and expands, you may find that it requires additional loans to fund purchase orders, invest in new equipment, hire personnel, etc. It’s a bad idea to continue taking out business loans in your name forever. As a bonus, you’ll find that you’ll typically get better interest rates applying for loans as a business as opposed to an individual.
How to separate your business and personal finances
The experts at JADDE Financial Solutions can help you successfully divide your business from your personal accounts. Additionally, we will ensure that your business accounting is set up correctly from the start – taking a huge weight off your back as you bootstrap your way into successful entrepreneurship!