When beginning a new venture, or consolidating and developing investments in a growing business, it is a common mistake to combine personal and business finances. Many young entrepreneurs make the error of trusting their fate with combined expenses and implement no distinct division between their business and personal accounts.
When a venture is new and lacks its own cashflow, an owner will often need to start by using their own funds; but continuing this practice as the company grows and becomes its own entity is a bad idea for several reasons.
When money becomes jumbled, and personal finances mix with business expenses, personal liability can be a tricky subject to manage. There are many interactions a business may have with clients, contractors, partners, and suppliers. Each of these relationships has the potential for injury as a result of faulty products or ineffective practices. Lawsuits and debts within a company are hard enough – owners certainly do not want these expenses following them over to affect their personal assets as well.
In these cases, it is especially important to have company accounts separate from personal finances. Any cashflow problems that a company finds itself in does not then carry over to an individual’s own accounts.
As an infant company especially, using personal finances for business ventures can end up putting those individuals in increasingly risky financial situations. The precarious nature of using one’s own funds for these investments means that the smart decision is to clearly separate the two and always view them as separate entities.
Additionally, this adds extra work and complexity to your bookkeeping process.
The Value of Incorporating
At the point that a venture has its own healthy cashflow, a fast and easy way to make all funds distinct is to incorporate the business.
In addition to aligning business finances with business services, and keeping personal finances at an arm’s length, the title of Limited Liability Corporation (LLC), C Corp, or S Corp also means tax benefits for some companies. When a company and individual’s finances are too closely intertwined, it is difficult for the IRS to validate tax deductible expenses, so making efforts to separate the two just helps them to do this. That means that when a business becomes incorporated, it’s a signal they are now properly handling money as well as making savings.
Business Accounts and Recordkeeping
Despite incorporating, a shared checking account between business and personal finances, or spillover from one to another, can make things a little messy still when it comes to liability and taxes. Opening a separate bank account to house only company finances is the way to go when attempting to distance personal money with that of the business.
A major concern when finances become mixed is that a company with no distinction between the personal costs of the owner and that of the business has no way of tracking expenses and losses. This would entail sitting down for hours to sift through which expenses were theirs and which could be attributed to the company.
Keeping accounts separate allows for the person who handles the finances to conduct easy research to determine what the business can afford and continue to budget their spending effectively. Not implementing these boundaries is a sure-fire way that both the company and the individual will get into financial difficulty.
In addition to all of this, tax deductible expenses can save owners a ton of money, but only if the venture is deemed official and less of a side project. Establishing designated bank accounts under the company name helps to solidify its independence and allows for tax-deductible purchases.
With separate bank accounts comes ease of tracking finances, spending and budgets. A skilled accountant, or even simply the owner, can make educated decisions about what the business can afford with this information.
Making a spreadsheet to track expenses by type, as well as earnings, is valuable in continuing to keep business expenses self-sufficient without delving into personal funds. Designating the money that will be used for investment and sticking to that amount hopefully means that the owner will never find themselves having to fund their established company from their own pocket.
When budgeting, owners who have incorporated their business as well as opened a separate bank account for it can take into account tax deductions when looking at expenses. Knowing what to deduct can be difficult at first, but according to the Internal Revenue Code, it will be any expense that is “ordinary and necessary.”
Make sure to read up on these rules so as not to miss any deductible expenses when filing. Accounting fees, which are used to create budgets and also to manage bank accounts, as well as bank charges themselves are often fully deductible. Also fully deductible are expenses related to:
- Consultation expenses
- Credit and collection fees
The main thing to consider when reordering finances is that it will be set in stone. Investing personal finances in a business is very common, but once this investment is deposited in the company account, try to regard this as no longer personal funds. Owners should not continue to funnel from personal funds because they have gone over budget, but rather, treat the initial investment as the money they have to work with.
Separate accounts help to draw this line, and being strict with spending helps to keep it there. Creating a viable budget means following through with the financial decisions that the business owner made early on, and determining how it can be effectively changed to be more realistic or more efficient month to month.
Build Better Business
Overall, the separation of personal and company accounts is a valuable step to saving more, making tax preparation easier, and accounting better for business expenses. Continue to take steps to build this divide between business and personal, like:
- Opening a separate bank account for your business
- Respecting the budgetary implications and not sharing money between personal and company accounts
- Incorporating your business as an LLC, S corp, or C corp
- Utilizing a separate card for work expenses
Take these steps so that the business can eventually stand on its own and grow into an exciting new venture.