April 21, 2022
Small business owners often make the mistake of combining business and personal assets and expenses. Unfortunately, mixing your money can lead to significant risks.
Here are some of the main reasons why you need to keep business and personal expenses separate.
1. Commingling Your Funds Increases Your Liabilities
Establishing a Limited Liability Corporation (LLC) makes your business a separate legal entity, which protects your personal assets should your business face a lawsuit or bankruptcy. However, commingling your business and personal expenses can eliminate this protection.
The business structure that you choose to protect your personal liability may not matter if you mix business and personal assets.
Failing to keep your business and personal expenses separate means that all assets are treated the same for legal purposes. Financial investigators may look at your personal assets when they figure out what your legal responsibilities are in a lawsuit.
2. You May Miss Out on Available Tax Deductions
Claiming business expenses and other tax deductions designed for business owners can lower your tax bill. However, mixing business and personal accounts can limit your ability to claim deductions.
The more assets you have, the harder it is to prove that your expenses were used only for business.
For example, businesses can often deduct various business expenses, such as the cost of the goods or services that they sell. If you mix accounts, you may struggle to determine which expenses were for business or personal use.
3. You Increase Your Risk of a Tax Audit
Mingling business and personal accounts increases your risk of a tax audit. You might forget to add up some of the information in your business or personal taxes, like income and operating costs.
If an audit occurs, the auditors may face difficulty trying to separate your expenses. This could make the audit take longer, which could keep you from getting a refund or make you pay penalties.
4. Mixing Accounts Creates a Lack of Organized Data
Using business and personal accounts interchangeably makes it more challenging to analyze financial statements. At the same time, you may not be able to keep track of your personal finances, which increases the risk that you’ll spend money from your business account on yourself.
Whether you manage your own books or work with an accountant, mixed expenses keep you from running your business smoothly. If you can’t keep track of your business’s cash flow, you can’t make smart financial decisions.
You can’t keep track of your business and personal budgets and financial goals because you don’t have enough information.
5. You May Struggle to Obtain Loans or Investors
Growing a business requires capital, which often comes from business loans or investments from outside investors. Banks and investors require a detailed analysis of your finances before giving you money.
For example, venture capitalists carefully review a business’s cash flow to determine whether it is a good investment. Banks need to review their financial records to analyze the risk of approving a loan. Without access to capital, you may not be able to expand your business.
How to Keep Business and Personal Accounts Separate
Mixing business and personal expenses is easy if you do not fully understand how to track your spending. Here are several examples of ways that business owners mix accounts:
- Using funds from a business account for personal use
- Using funds from a personal account for business use
- Using a single account for both personal and business transactions
- Checks intended for a business account are deposited into your personal account, and vice versa.
- Transferring funds between accounts without maintaining documentation
- Creating a separate business account is one of the first things that small business owners should do after establishing a business.
- Your business account should only be used for business expenses. All incoming business payments and refunds should also go straight into your business account.
- Using accounting software can also help business owners with their bookkeeping. For example, QuickBooks Online makes it easy to keep track of business expenses, invoices, and financial reports.
- Along with these suggestions, you may consider hiring an accounting firm. Professional accountants can help you make sure that you keep track of all of your business expenses and income.
Keeping business and personal expenses separate is one of the challenges that new business owners often struggle with. You may pay with your personal funds when taking clients to lunch or use a business account to cover some of your personal expenses. These seemingly simple transactions can interfere with your bookkeeping.
Mixing your accounts increases your liabilities. You lose financial protection as your personal assets become entwined with your business assets. You may also miss out on tax deductions and increase your risk of an audit.
The lack of organized data also increases the difficulty of reviewing profits and financial goals. Without separate accounts, you may also fail to get bank loans or attract investors.
Create a separate business account to avoid these issues. However, for the best results, use accounting software or hire an accountant.
If you need help with your bookkeeping and accounting, don’t hesitate to schedule a consultation with us!
Even though we are based in Albany, NY, we offer our expertise in business accounting, bookkeeping, and tax preparation all across the United States.