Why Mixing Business and Personal Finances is a Big Mistake: A Bookkeeper’s Perspective
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As an experienced bookkeeper, I’ve seen firsthand the chaos that can ensue when resellers fail to separate their personal and business finances. One particular business owner, let’s call him John, had a thriving online reselling business but constantly mingled his business and personal expenses. The confusion not only complicated tax season for John but also hindered his ability to see the financial health of his business. He also ended up paying more business taxes because of this serious mistake.
In this blog post, I’ll walk you through why separating business and personal finances is crucial and provide practical steps to help you achieve financial clarity.
What Does It Mean to Separate Business and Personal Finances?
Separating business and personal finances means keeping the funds you use for your business separate from the money you use for yourself and your family. Think of it like having two piggy banks: one for your business and one for your personal use. While using the same bank account or credit card for both might seem convenient, this approach can lead to numerous complications.
Think about your reselling business. For those who do resell arbitrage, you may buy both inventory and personal clothing from TJ Maxx. If you don’t pay for your inventory with a business card, you will not know which TJ Maxx purchases are business or personal. Similarly, suppose you occasionally buy shipping supplies from Walmart using the same card as your groceries. In that case, it will take time to quickly see which Walmart purchases are personal and which are business-related. Let me explain more about why separating your business and personal transactions is so crucial!
Why is Separating Business and Personal Finances Important?
Before we discuss why separating personal and business funds is essential, let’s discuss the elephant in the room… Why do resellers think it’s not important? Resellers usually start their business as a side hustle. It’s just a way to help pay for Christmas presents, a vacation, rent, or even a new car payment. They don’t see it as an actual small business because they haven’t created a business entity (like an LLC). BUT, once you start having sales, you are required to report your income to the IRS. This requires you to organize your finances from the start. Separating your business-related expenses and income from personal expenses is necessary!
Here’s why it’s important for a small business owner:
Easier to Track: It helps you see exactly how much money your small business makes and spends. This makes it easier to know if your business is doing well or if you need to make changes.
Saves Time: When it’s time to do your taxes, having separate accounts makes it quicker and easier to figure out your business expenses. This way, you don’t mix up business expenses with personal expenses. It also makes your bookkeeper’s job easier throughout the year! AND I promise you… your CPA or tax professional will thank you BIG!
Professionalism: Using a separate business bank account shows customers, suppliers, and even the bank that you are serious about your business.
Legal Protection: If something goes wrong with your business, having separate finances can help protect your personal money from being used to pay business debts. However, to get these protections, you will want to talk to a CPA/lawyer about setting up a business entity. In many cases, the LLC will be a good option.
Why is separating business and personal finances important?
Best Tips for Separating Business and Personal Finances
If you don’t want to end up with the tax bill or stress that comes with mingling your business and personal expenses, here are some ways to get started!
Operating without an LLC:
By establishing clear boundaries between your personal and business expenses, you can make managing your money easier, ensure compliance with tax regulations, and protect your personal assets. Here are key steps to help you effectively do this if you do not have an LLC yet:
Consider Forming an LLC: Evaluate if forming a Limited Liability Company (LLC) suits your business needs, considering legal protection and tax benefits. Discuss this with your CPA to see what is the best fit for you.
Open Separate Accounts: Open a dedicated bank account and credit card to keep business finances separate from personal finances. You can’t open an official business bank account without a legal entity and other business documents. However, you can still open another personal bank account that you only use for the business.
Direct Business Income: Ensure all business cash flow runs to this account.
Use Separate Cards for Expenses: Use the business credit card and debit card exclusively for business expenses to simplify tracking and avoid mixing personal and business transactions.
Review Personal Accounts: Regularly check personal accounts for any business-related transactions. List these transactions and transfer them to the business account promptly to maintain financial clarity.
Pay Yourself a Salary: Transfer a fixed salary from your business account to your personal account to clearly separate personal and business finances.
Implement a Bookkeeping System: Use a reliable bookkeeping system to track income and expenses accurately. My Reseller Genie is a bookkeeping software designed specifically for resellers. Consider hiring a professional bookkeeper to manage this task efficiently.
Collaborate with Professionals: Work closely with your bookkeeper and Certified Public Accountant (CPA) to ensure all business expenses are properly categorized and deducted for tax purposes.
Operating with an LLC:
If you already have an LLC and Employer Identification Number (EIN), here are some helpful tips to make your business finances simpler and safer:
Open a Business Bank Account: Use your LLC documents and EIN to open a dedicated business bank account.
Direct Business Income: Ensure all business cash flow runs to this account.
Use Dedicated Business Accounts: Use only a business checking account (debit card) or business credit card for business expenses.
Review Personal Accounts: Check personal bank accounts for any business transactions. List mixed transactions and promptly transfer them to your business account.
Pay Yourself a Salary: Transfer a salary from your business account to your personal account.
Implement a Bookkeeping System: Use a bookkeeping system, like My Reseller Genie, to track your business finances effectively. My Reseller Genie is a great software resellers can use to track business expenses and income. You can also run all of the reports necessary for tax season.
Consider Hiring a Bookkeeper: Delegate transaction tracking to a bookkeeper to focus on other business aspects.
Work with Professionals: Collaborate with your bookkeeper and CPA to ensure proper deduction of all business expenses from your taxes.
Common Questions About Separating Business and Personal Finances
Does an LLC really protect your personal finances?
Generally, yes! An LLC (Limited Liability Company) helps keep your personal money safe if your business gets into trouble. This means if someone sues your business or if your business owes money, they usually can’t take your personal stuff like your house or car. Also, an LLC makes your business a separate “person” in the eyes of the law. So, your business debts and problems don’t mix with your personal ones.
However, there are situations where an LLC might NOT protect your personal finances. Here are some examples:
Personal Guarantees: If you personally promise to pay back a loan or debt for your business, you’re responsible even if your LLC can’t pay it back. So, be careful when signing things!
Mixing Finances: If you mix your personal money with your business money, like using your business account to pay for personal stuff, the protection might go away. This is why it’s super important to keep them separate.
Illegal or Wrong Actions: If you do something unlawful or wrong, like fraud or lying about your business, an LLC won’t protect you. You can still get in trouble personally.
So, while an LLC gives you a lot of protection, you have to follow the rules to keep that protection strong!
Should I link my personal bank account to my online accounting system?
Linking your personal bank account to your online accounting system can simplify tracking your finances and give you a clear overview. However, it comes with risks like potential security breaches and mistakes in your business records. To balance convenience with security, make sure your online security is strong and keep your personal and business finances separate. Regularly review your transactions and consider getting advice from a bookkeeper to help you effectively manage and protect your finances.
Am I personally liable for my LLC debt?
An LLC is a separate legal entity that usually shields you from being personally responsible for business debts. But there are exceptions, such as if you personally promise to pay a debt or do something illegal. These situations could put your personal assets at risk. It’s smart to talk with your CPA to know exactly what you’re responsible for.
Can I take money out of my business account for personal use?
Yes, you can take money out of your business! Depending on how your business entity is set up, you can pay yourself through payroll or owner distributions. Just remember, do NOT use your business debit or credit card to pay for your next set of groceries!
Business and personal finances, why are these important to separate?
Conclusion
As we wrap up, let me emphasize once more how crucial it is to keep your personal and business finances separate. Mixing these can lead to major headaches during tax season and make it hard to see the true financial health of your business. Remember John's story? Because of this mistake, he paid more taxes and couldn't accurately gauge his business's performance.
One simple step to consider is opening a dedicated business bank account and using it exclusively for all business transactions. This can save you time, prevent errors, and provide clear financial boundaries. By staying organized and diligent, you can protect your personal assets, look more professional, and make smarter business decisions. Stick with this practice, and you'll be on the right path to a successful reselling business.
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