You’ve been warned about mixing business and pleasure, but what about personal finances and business finances? At times, it may seem tempting to use your personal finances, whether that’s a personal credit card or personal bank account, to help out when your business needs a boost, but that can create problems for your business. 

Drawing a clear line between personal and business finances helps small business owners treat their business a legit business, while safeguarding their personal finances.

Learn why it’s so important to separate personal and business finances and how to get started today.

Why Is Separating Your Finances So Important?

Though there are many benefits to keeping your personal and business finances separate, liability and taxes are the top two.

Personal liability

Protecting your personal finances is one of the main reasons you’ll want to separate your finances. 

Entrepreneurs often wind up leaning on their personal finances by signing personal guarantees for leases, loans or lines of credit. They may use personal credit cards to pay business expenses when cash flow is tight. 

Sometimes that’s necessary — especially when your business is young and hasn’t established a strong business credit rating. But your goal should eventually be to avoid personal guarantees as much as possible. The way you do that is by building strong business credit, so lenders can be confident that your business can and will repay its debts

Taxes

One of the main reasons you’ll want to split your business finances from your personal finances is taxes. It’s much easier to keep track of business-related expenses if you use a separate business account. That, in turn, makes it easier to take advantage of tax deductions and helps tax season a lot easier. 

From office expenditures to operational and inventory purchases, every receipt counts. When it comes time to file your taxes (or hand everything over to your accountant), this documentation may help you write off expenses.

How to Separate Your Business Finances

Now that you understand two of the more significant reasons to keep your business and personal accounts separate, let’s take a look at a few of the ways that you can proactively put this division in place.

1. Form a business entity

Forming a limited liability company (LLC) or a  C corp vs. S corp can provide tax benefits, but more importantly help protect your personal assets, provided you set it up properly and maintain it correctly.

A sole proprietorship is not a formal business structure. If you operate as a sole proprietor, there’s no legal separation between you and your business. 

By maintaining a legal entity, you can protect your personal assets from business debts, losses and lawsuits. (Keep in mind, though, that if you sign a personal guarantee, creditors can try to collect from your personal assets if your business defaults on a debt.) 

If you’re serious about creating a business, forming a legal business entity is a smart first step.

2. Get an Employer Identification Number (EIN)

An EIN, or Employer Identification Number, is a unique nine-digit number assigned by the Internal Revenue Service (IRS) to business entities operating in the United States. It’s essentially a Social Security number for businesses.

Not all businesses need one. 

But it can still be helpful to get one, both for filing taxes, and as another way to keep business and personal finances apart from one another. (When you apply for a business credit card, for example, you may need to provide a Social Security number for a personal credit check, but also providing an EIN can help ensure that account is reported correctly to business credit bureaus.)

Here’s how to get an EIN for free.

3. Open a business checking account

Once you’ve made the decision to start your own business, one of the very first things you should do is open a business checking account. There are multiple reasons why this is a healthy step for a business. 

For starters, it will streamline cash flow and make financial record keeping much more efficient. Additionally, a business bank account makes it easier to track your cash flow. 

It also helps you keep track of your business transactions and income, which makes it easier to keep up with your bookkeeping. Many business checking accounts can sync with accounting software, which also makes things easier at tax time. 

As mentioned before, a separate business account can help signify to the IRS that your venture is a business and not just a side project or hobby, which may potentially help you tax advantage of valuable tax deductions.

Finally, if you do need financing, keep in mind that many small business financing options require business bank statements to verify revenue. 

4. Get a business credit card

A business credit card makes it easy to track business purchases. If you use a personal credit card, you may find it difficult to track which purchases you made for personal expenses versus business purposes. Business credit cards often offer lucrative rewards, including cash back or travel rewards. You may even be able to deduct card costs (an annual fee and interest, for example), if you use it exclusively for business purchases. That may not be the case if you mix personal and business expenses on the same card.

But a business credit or charge card can offer additional benefits. 

Building business credit can help your business qualify for small business loans and financing. 

Most business credit cards help build good business credit scores if you pay on time and keep debt low. And you can protect your personal credit history since business credit cards rarely report to personal credit. (If you default, though, many issuers reserve the right to report that default to your personal credit.) 

5. Build business credit

Establishing business credit is a crucial step toward separating your personal and business credit. Your business can have its own business credit reports and business credit scores, so you don’t have to rely as heavily on your personal credit scores. 

Good business credit can open up financing options that may not be available otherwise. 

6. Get business insurance

In addition to protecting your business in the event of lawsuits or losses, business insurance may be required for legal reasons. Some clients may require it, for example. You won’t be able to rely on personal insurance alone. 

If business equipment is stolen from your home office, for example, your personal insurance may not cover it. Similarly, if you get in an accident while using your personal car for business, your insurance may not cover it. 

7. Set a business budget

Being armed with a business credit card and a business bank account is a terrific start, but there’s another step that really can help you keep things in check — a business budget. It doesn’t seem like setting a budget for your business would do a whole lot in terms of separating personal and business finances, but it can. 

Preparing (and sticking to) a budget for your business can prevent you from falling back on your  personal finances if cash flow is tight. Of course, emergency situations can happen, and even the best planned budgets may not always work out as intended. 

However, by creating a clear cut budget, you’ll be able to reduce the risk of running into financial surprises that would otherwise leave you turning to your personal finances. And you also increase the odds of creating a financially healthy business. 

How to Effectively Separate Your Business and Personal Finances for Tax Purposes

We’ve touched on this earlier, but it bears repeating. The more clearly you separate your finances, the easier it is to file accurate tax returns on time. Here are three steps you can take to make it easier:

• Always use a business credit card (or business debit card) for business purchases. Avoid using a personal credit card for business expenses. Keep receipts for all business expenses. 
• Use a business bank account. Don’t commingle personal and business funds in the same account.
• Pay yourself. Don’t pay for personal expenses directly from your business bank account. Instead, pay yourself, they pay for personal items out of your personal account. 
• Stay up to date on your bookkeeping. Get behind and you may have trouble catching up. But just as importantly you may lose track of the financial health of your business.

How Nav Can Help

Nav can help you separate your business and personal finances by choosing a business formation service, accounting software, and business tax solutions. 

Nav Prime makes it easy to build, manage, and leverage your business credit all in one place. 

And when you’re ready for financing, Nav can help you find the right business credit cards and small business loans for your business. Get started with Nav now.