Whether you operate a Sole Proprietorship, Partnership, Limited Liability Company (LLC), Limited Liability Partnership (LLP), or Corporation, how you manage your finances is a vital aspect of running your business.
While using your personal bank account for business might seem like the simplest solution, it’s not a good idea for a variety of reasons. Mixing your business and personal finances can result in problems ranging from tax consequences to your business appearing to be unprofessional. Let’s take a deeper dive into some reasons why keeping your business and personal bank accounts separate is always a smart move.
1. It Helps You Determine Business Performance
Regardless of the type of business you’re running, calculating income and expenses to measure profitability is essential. And because you’re busy with the many responsibilities that accompany operating a business, you want to be able to do that quickly to make sure your business performance is on the right track.
Having separate business and personal bank accounts makes it easier to track business performance because it keeps transactions separate, eliminating the need to sift through accounts while trying to remember if a particular transaction was a business or personal expense. This is especially true if you’re at a point where you’re making more business transactions than personal ones.
2. It Enables You to Change Your Business Entity
While a sole proprietorship or general partnership is not required to have a designated business bank account, an LLC or Corporation must because they are separate entities from the individuals who own them. Also, the name of a business is likely to change when it becomes a different type of entity, meaning that a new bank account is necessary.
If you were operating as a sole proprietor and using personal bank accounts, you cannot form an LLC or Corporation without a business bank account that reflects the name of your business. Even if you had a designated bank account as a sole proprietor, you’d need to open a new account because the new business entity is considered a new and separate organization.
Also, if you convert from a sole proprietorship or general partnership to an LLC or Corporation, you must apply for a new employer identification number (EIN) for the company. The EIN is a company’s identifying number for tax purposes.
3. It Keeps Separate Businesses Separate
Some industrious entrepreneurs operate more than one business, such as a catering service and a cupcake shop or a lawn cutting business and a mower repair shop. Trying to keep the finances of more than one business separated from each other can be difficult—doubly so if you’re using a personal bank account and also have personal funds and expenses involved.
If you operate more than one business, it’s extremely important to have separate business accounts for each one and avoid commingling funds. Don’t move funds between accounts and keep all their activities separate. This makes it much easier when it’s time to pay taxes and keeps your banking activities clean and organized. It also makes it easier to measure the profitability of each business and to make decisions concerning how they should be operated.
4. It Helps Protect Your Personal Assets
Liability issues are a real threat to a business owner. Forming your business as an LLC or Corporation has legal benefits in that it legally separates you from your business, creating a shield between business and personal assets. If you are sued or creditors are seeking to collect from your business, only the assets of the business are at risk. Your personal assets, such as bank accounts, your home, car, and any investments are protected.
Having separate business and personal bank accounts is essential to keeping that legal barrier in place. If you’re sued and a court determines that you haven’t treated the business as a separate entity or have commingled personal and business funds and assets, it can take an action called “piercing the corporate veil” and hold the owners of the business personally liable.
Another argument for separating business and personal accounts is the possibility of financial hardship forcing you to file for bankruptcy. If your personal and business financials are intertwined, your personal financial history takes a hit. It doesn’t matter if your business woes have nothing to do with your ability to handle money in your personal life. Your personal credit score will suffer as a result, which can negatively impact your chances of getting an affordable business loan or a line of credit when you need it.
Additionally, as your business grows, resulting in an increasing number of business transactions, drawing clear lines between your personal and business accounts helps protect you from having your personal identity stolen. Because a business bank account requires an EIN, you can use that number in business matters instead of your Social Security number, decreasing the risk of identity theft.
5. It Keeps Uncle Sam Happy
The bigger your business, the more complicated things get at tax time. Keeping personal and business transactions separate can make it easier because you know exactly which expenses were for your business and which expenses were personal. The IRS has stringent rules that require business money to be used strictly for business purposes. Maintaining separate bank accounts makes it easy to prove you’re spending business money on legitimate business expenses, such as paying for supplies or software subscriptions.
Also, having a dedicated business account makes it easier to categorize expenses and identify deductions, as many small business checking accounts are compatible with readily available business accounting software. Tax deductions can be very advantageous to a business, making it important to be sure you get all those to which you’re entitled. Accidentally writing off personal expenses as business expenses, however, can land you in hot water with the IRS.
6. It Improves the Image of Your Business
Being unable to accept a customer’s credit card payment or paying a supplier with a personal check does not convey professionalism or a high degree of credibility. Having a dedicated business bank account and checks, credit cards, and other payment methods that contain your business name lets others know you are serious about your finances and planning to grow your business.
7. It Helps Prepare Your Business for Growth
Having an established business account is helpful in establishing credit for your business, which could be beneficial if you want to apply for a business loan or line of credit. It also allows your business to cultivate a relationship with a financial institution that can assist you as your business grows. For instance, if at some point you hire employees and want to establish a 401(k) plan for them, a bank can help you understand your options and find a plan that suits your business needs.
The Next Steps
Now that you’re ready to open a business account, take some time to determine what kind of account you need. The U.S. Small Business Administration advises finding a business checking or savings account with low fees and good benefits, such as introductory offers and low to zero transaction fees. Pay attention to any monthly minimum fees that may be required and look at the interest rates for lines of credit or business loans that you may want to access at some point.
Certain banks offer services that cater specifically to small businesses and their needs. Some banks have business accounts for high-volume deposits and monthly transactions, while others have low-cost checking accounts or are good for businesses that import or export products.
Once you’ve found your bank, check that you have everything you need to open a business account, such as:
- Your company’s EIN or federal tax ID number.
- Your business license with the name of your company and of all its owners.
- The documents you filed with the state, such as a certificate of good standing or any paperwork that shows how your business is structured.
As your business grows, you’ll have more and more responsibilities to deal with. Keeping your business and personal finances separate can help you operate more efficiently and effectively, safeguard you from liability, and poise your business for growth.
