Keeping Business and Personal Finances Separate: Why It's Important
By: Shay James
Starting your business as a budding creative agency can generate an overwhelming sense of excitement. Setting out with your own company, charting your course, and being your boss feels like an exhilarating dream come true.
Hopefully, that excitement never wears off. But the truth is, if you’re past the startup phase of your business, you’re probably realizing that there are certain components of running a business that you may have underestimated.
This feeling is common, especially among creative agencies like yours, because the skills that make you such a talented creative force are usually the same reasons you feel repelled by the uninteresting, rigid, and complex aspects of business finances and accounting. Sometimes we hate to admit it, but a big part of running a business entails a keen eye for things like cash flow, investments, and taxes.
One common mistake new business owners make is not separating business and personal finances as they grow.
Why You Should Be Separating Business and Personal Finances
Your Business Structure Matters
How you’ve chosen to set up your business is a big driver of how you manage your finances.
There are multiple ways to structure a business, but the two most common are either a sole proprietorship or a limited liability company (LLC).
If you’ve chosen to operate as a sole proprietorship, this means you (the business owner) and the company are the same entity. You own everything the business owns, including debt and liability.
Sole proprietorships are some of the simplest and easiest ways to open a business, but over time, as your business grows, it may not be ideal. If you’ve structured your business this way, you’re most likely running all of your deposits and withdrawals through your personal checking account.
When a business is in its startup phase, this may not be such a big deal. However, the more intertwined your business and personal finances become, the more challenging it becomes to accurately file taxes or assess the overall profitability of your business.
Perhaps you’ve chosen to scale your business up a bit and you’re running as an LLC. Good for you! This is an exciting step in your growth. In this instance, it becomes even more crucial to keep your business and personal finances separate. If you don’t, you forfeit the protections your company provides you as an individual.
Additionally, the way you move money to and from your business must be done correctly to comply with IRS rules. Make sure you have the help of finance and accounting professionals to understand these rules so you don’t make a costly error.
The important thing to remember is that once your company is an LLC, separating business and personal finances isn’t really optional…it’s the law.
If you’re a creative agency then you’re already aware of the importance of marketing and image. Separating your business and personal finances helps your business maintain a more professional image. It tells your clientele you are qualified to handle their business effectively.
When you make financial transactions like invoicing or business purchases, the process needs to be clean and streamlined. Anything less than perfection is an inconvenience for your customer and can drive business away. But intermingling company and personal funds can make things cumbersome. You don’t want your clients to get the impression your business is a side-gig. Make sure your financial structure reflects that.
This may mean opening a business checking account, creating a business tax ID, and using accounting software that keeps your business transactions out of your personal bank account.
Maintaining separation between work and home helps give the impression you’re a professional who knows what they’re doing and not just someone who is making things up as they go along.
When your business is lean and scrappy, every dollar matters. It can be extremely difficult to determine your revenue, expenses, or net profit when personal and work accounts are blended. Keeping track of purchases or income is a nightmare in this scenario.
To get a clear picture of how your business is doing and where you’re most profitable, you need reliable info. By having all your money separated you’ll have a much better chance at success. With company money in its own accounts you can accurately find out what’s working well and which parts of your business you need to adjust.
Having access to loans and capital to help grow your business is crucial to your success.
Just like with a personal credit score, your business will develop a credit score by which banks gauge your creditworthiness. However, for this to happen you have to keep business accounts separate from your own.
This is important not just for the ability to acquire lending, but also when considering liability. Once you’ve set up an LLC and begun keeping finances separate, you will no longer be personally liable for the debt your business holds in the unfortunate circumstance it defaults.
Business credit is really important if you think you will need to access funds to invest in your company as it grows.
4 Steps to Separate Your Business and Personal Finances
1. Open Separate Bank Accounts
Just like you have a personal account, your business should too. This means all your purchases and sales run through an account that isn’t commingled with your money.
Not only will this lead to better bookkeeping, but it can help make sure you don’t make a costly mistake that may undo the protections granted to your business.
2. Obtain an EIN
An EIN is an Employer Identification Number. Think of it like the social security number of your business.
You’ll need the EIN to help fill out paperwork, open business accounts, or complete certain transactions with the IRS. It’s an important step to take to help make sure personal finances and your business finances are completely separate.
3. Pay Yourself
Perhaps you’re wondering how you’ll get paid if your finances are completely separate. The simplest answer is: you’ll give yourself a paycheck from your business.
Just like when you work for someone else, your paycheck comes from the company and is then deposited into your personal account. This will help keep your business budget on track which is valuable as a business (not to mention it’s another key step for success!)
4. Hire An Outsourced CFO
When it comes to your business finances, things can get complicated quickly. It’s not unusual to feel overwhelmed and stressed as your business grows, especially when it comes to the areas you don’t understand well.
Getting quality guidance from a financial professional or accountant can help businesses avoid simple mistakes right from the start. How money flows to and from your business has huge implications for the future of your company and you’ll want to make sure you get things right.
Not only will sound financial structure and process help you keep your company afloat, but it may also give you a chance to focus more on the aspects of your business that you love.
Keep Your Accounting in Check with Lamplight Advisors
At Lamplight Advisors, we regularly work with companies that are growing rapidly and may be having difficulty navigating certain parts of their business environment. We make it our mission to help creative agencies structure themselves so they feel confident the financial aspects of their businesses are being taken care of. To see if we can help you evaluate your business structure so you are operating efficiently, click here to schedule a conversation today.