Keeping Business, Personal Finances Separate

Understandably, most small business owners live and breathe their businesses. They were involved from the beginning and immersed in all aspects of operations, putting in the long hours and resources it takes to make a business grow.

Because small business owners are so personally involved in each area of their startup, personal and business finances can get intertwined before they know it. Although the Internal Revenue Service does not require separate bank accounts for sole proprietorships, it’s worth taking the time to create distinct accounts for personal and business expenses for several reasons.

• Tax purposes. The IRS strictly enforces its rule that only businesses can deduct business expenses. If you use a personal bank account for business expenses, it can be harder to convince the IRS you are operating a legitimate business. Also, it will take much more time to separate business from personal income and expenses if they are on the same bank/credit card statement. The IRS requires that all records be accurate, complete and permanent. If you have a separate business account, showing a clear record of business-related income and expenses will be easy.

• Performance analysis. When your personal financial matters are woven tightly into the books of the business, it becomes difficult to analyze how the business is performing. When you carve your personal finances out of the equation, you can begin to decipher whether profit margins are appropriate for your industry and if you have the capital you need to remain competitive.

• Personal financial picture. Looking at your personal financial picture independent of your business will benefit you tremendously. In many cases the value of the business is listed as the only major asset held by the owner and the only retirement asset that is available. The hope is that the business will serve as a source of liquidity and provide for you in retirement, but it’s important for you to take care of yourself along the way.

After you’ve established a separate account for business purposes, start paying yourself a salary instead of taking draws only when you need money. Your business will recognize a fixed expense each month, which allows you to better analyze month-to-month results. You’ll take home a consistent amount and can begin building wealth outside of your business.

As a business owner, it’s important to know your books and invest some time understanding your financial statements. Scrutinizing cash flow will lead to improvements in your business and financial operations.

On the personal side, draft a financial statement by listing all assets and liabilities that make up your net worth position. Take out the value of your company to get an objective view of your net worth independent of the business. The statement will help you answer key questions about financial liquidity and help you plan for the future.