One of the most exciting things you can do in your life is decide to start a new business. By choosing to become an entrepreneur, you will have the opportunity to see your dreams eventually become a reality. However, one of the most common reasons that individuals with good ideas decide not to become an entrepreneur is because they are unsure they will be able to properly manage their finances. In fact, many entrepreneurs who do not properly prepare for the future are likely to find themselves in debt or even personally bankrupt.
Fortunately, there are many different strategies you can use to plan for the future and become more responsible. This article will briefly explore some of the top strategies for keeping your personal and business expenses separate and how you can use these strategies to run your business more successfully.
Create separate bank accounts for personal and business use
Combining your personal and business bank accounts is one of the surest ways to quickly find yourself in debt. In theory, these accounts could be organized with a well though-out and detailed system, but simply trying to “keep track” of things “in your head” exposes you to an avoidable degree of risk. Once you begin seeing the revenues from your business pour into your account before your debts have been paid, it becomes far too to spend money on yourself that—although it is in your bank account—you really do not have the right to actually spend.
Creating a business bank account is something that is relatively easy and can likely be done with the bank you are already using for your personal banking needs. Having all revenue streams go directly to this account and having all expenses paid with an independent business credit card will make it significantly easier for you to accurately and responsibly separate business from pleasure over time.
Pay Yourself a Salary
Even if you are running a sole proprietorship or are the only person involved in your specific business, it will often be a much better idea to pay yourself a “salary” instead of simply spending whatever equity your business has earned. Having a personal salary gives your business a more authentic opportunity to build equity over time, helps you live off of a more predictable payment schedule, and also helps you keep both your business and your life significantly more organized.
Paying yourself a salary is simple. Begin by analyzing previous financial statements, current (personal) financial needs, and try to demonstrate a figure you believe you could reasonably live off of every two weeks. Then, all you will need to do is regularly transfer payments from your business bank account to your personal bank account, effectively functioning as a salary. If you are the sole owner of your business, this salary is something that could be customized (for example, scheduling a larger payment near the time of the month your rent is due). But even with the benefit of flexibility, taking this step to keep your accounts separate is something that will undeniably pay off over time.
If you are a sole proprietor, create an additional account for future taxes
One of the most common traps for entrepreneurs is that, come every April, they are not properly prepared to pay the taxes they have due. Though the Internal Revenue Service (IRS) recommends that you pay a portion of your taxes every three months, doing this is something that is not legally binding. This can create a uniquely hazardous situation for entrepreneurs that become dependent on future cash flows that do not end up materializing.
Not all small businesses are taxed all at once in this manner, but there are certainly very many that are. Instead of paying the IRS on a quarterly basis, it is likely much better for your business (as well as your overall equity level) for you to create an additional bank account that you plan on liquidating for paying your taxes and absolutely nothing else. In order to anticipate the level of taxation you will likely be subject to, you should look at previous tax statements and compare them to your yearly projections. Then, with every month of “untaxed” revenue, you should transfer the appropriate amount to your special savings account. Once the money is actually in the account, you should consider it to be functionally spent.
Consider forming a Limited Liability Corporation (LLC)
Even if you are the sole owner of your business (and likely running a sole proprietorship in the status quo), you may want to consider creating a Limited Liability Corporation (LLC). LLCs can be created for businesses in a wide variety of industries and a wide variety of different sizes. Essentially, an LLC is a legal entity independent of the business owner(s) that is specifically designed to help minimize personal liability and stay more organized.
Once you have created an LLC, your business and personal expenses will be formally separated. With an LLC, debts, expenses, and risks assumed by the business will not directly affect the well-being of your personal bank account or even directly affect your credit score. In many ways, LLCs can be claimed to sincerely offer the “best” of both worlds. While these entities give you protection from liabilities like a corporation (C Corp), they also offer you the flexibility and minimal taxation of a sole proprietorship.
Keep Track of Shared Expenses
While you should be keeping track of all expenses and receipts you accumulate over the year, it is also very important to keep track of anything that could be considered a shared expense. Once it is April again, you may be surprised just how much you will be able to legally deduce from the amount of taxes that you owe. In general, the Federal Government has a very generous definition of what can be considered a tax deductible business expense. Being able to right off of things such as Wi-Fi, office supplies, travelling expenses, a new computer, and even a portion of your rent (if you work for home) can dramatically reduce your annual liabilities.
Ultimately, keeping your business and personal expenses separate can be a rather difficult task. After all, if you are a committed entrepreneur, you likely consider your business to be a major part of your life. But by carefully keeping track of things, establishing multiple different bank accounts, and strategically restructuring your business when appropriate, you will find yourself in a much more financially secure position.
Andrew is an experienced writer with degrees in Finance and Political Science from the University of Colorado. He also has experience in the real estate and life insurance industries. His other primary interests include economics, entrepreneurship, political philosophy, and nature.