A key thing that every small business owner should do is to keep his/her personal and business expenses and all other finances separate.
Who Must Keep Personal and Business Finances Separate?
If a business is formed as a corporation, it is considered a separate legal entity so all finances and business expenses must be separated. If a business is formed as a sole proprietorship, there is no legal distinction between the business and its owner. Therefore, all profits, losses, and liabilities are linked to the owner personally. So, it is critical that personal and business finances be kept separate in case of an IRS audit.
Why is it Important to Keep Business Expenses and Finances Separate?
Probably the most important reason is for tax purposes, both to receive proper benefits from tax deductions and to avoid problems with or penalties from the IRS. As a business owner, it is allowable to take certain business-related deductions for business expenses including travel and supplies. A valid claim for these deductions requires clear documentation. If an IRS audit takes place, the auditor will examine every expense to ensure it is a business-related expense. Thus, clear and accurate documentation will help an owner quickly clear (or avoid) an audit.
Separated business and personal finances make it easier to get business loans or to establish lines of credit. Comingled accounting causes red flags for lenders. Lenders will need to see clean records of cash flow, revenues, and all expenses to determine suitability for a loan.
Keeping personal and business finances separate makes recordkeeping much easier. And when working with a certified public accountant or accounting firm, good financial documentation simplifies their work and reduces the cost of their time.
Keeping business expenses and finances separate enhances the professional image of the enterprise. It also improves a business’s ability to establish a good credit history.
How to Keep Business and Personal Finances Separate
Use these tips to keep personal and business expenses and all other finances separate:
- Open a separate bank account in the name of the business. This will require a formal business name and EIN number. The bank can advise you regarding what type of business account will be most advantageous for your business.
- Get specific financing for your business operations. That can be a business line of credit, a commercial term loan, an SBA loan, or another business financing method.
- Get a business credit card and only use that card for business expenses. It can contribute to an increased business credit score and can offer the benefit of cash back on purchases. It also assists with expense recordkeeping.
- Keep all business receipts and financial records separate.
- Pay yourself an ownership salary. That will solidify the line between a person’s finances and business finances.
- Establish a comprehensive accounting system so that the owner himself/herself doesn’t have to keep track of all the business transaction records.
- Hire a professional accounting company, a certified public accounting firm (CPA). They will know all the up-to-date accounting regulations and can offer systems, processes, and strategies to protect an owner and deliver the best possible financial results.
- It is important to keep financial records organized and up to date and to have dependable office staff work with all financial records.
Get Expert Tax, Accounting, and Financial Assistance
Contact Doerhoff & Associates, CPA, based in Jefferson City, MO for professional accounting, financial assistance, and tax preparation that you can count on. Doerhoff & Associates has one goal in mind, to provide comprehensive business accounting services designed specifically for your success.