Many small business owners struggle to keep their business net worth separate from their personal net worth. It's tough when your personal identity is so closely entwined with your company's. But for both your financial and personal health, it's important to create a dividing line between the two.
Build a Wall
Separating personal and business finances is a must, experts say. Here's why: Whether you're a sole proprietor, a partnership, or a corporation, keeping your accounts separate reduces your personal liability, makes your business more credible, and helps you manage taxes and bills, reports the Small Business Administration (SBA).
A separate business checking account and credit card can help to build a wall between your personal assets and credit score if your small business runs into trouble. This is especially important if your business is incorporated, because it's a separate tax-paying entity, according to the SBA. Building a separate credit profile for your company can also enable you to access 10 to 100 times more credit than you could as a consumer, writes Levi King, chief executive and co-founder of Creditera, a service for building business credit.
A business bank account also gives your company additional credibility and a more professional image. And it helps you keep accurate records of business and personal expenses – a huge benefit come tax time.
It's hard to have the perspective to make good business decisions when personal funds are at risk. On the flip side, overinvesting in your business can also impact your personal life by putting your emotional and financial stability at risk when your business encounters obstacles.
Setting a clear budget for your small business –- and sticking to it -- can help prevent situations where you have to cover shortfalls with personal funds. And while it's tempting to reinvest all of your profits back into your business, it's important to pay yourself a steady salary from your business account each month to keep your personal finances stable, reports the SBA.
In the beginning, it helps to keep business spending to a minimum until you have more consistent earnings. Skip the fancy office and the impulse to overload on initial inventory. “Focus instead on building a good product and customer experience," the SBA advises. A great way to avoid these initial spending pitfalls is to start a business online or from home.
Have a Back-up Plan
Even though it's easier than ever to start a new business thanks to the advantages of the Internet era, about seven out of 10 startups will fail by their seventh year of operations, according to the SBA.
That doesn't mean you shouldn't pursue your small business dream. But you should have a back-up plan. Although planning for a worst-case scenario may seem like a lack of faith in your business, it pays to be prepared for failure.
Whether you work a second job, or create a cash reserve to cover six months of personal expenses, it's important to have a safety net for your business. It's also a good idea to diversify financing sources, writes Mariah Courtney of Biz2Credit, an online marketplace for small business lending.
Another way to reduce risk is to avoid making your company a one-person show, Courtney advises. If you need to take a day off, make sure your company can function while you're away.
While it's easy to self-identify with the business you pour your heart into each day, it's essential to keep personal and business finances separate. Building a wall between personal and business accounts, avoiding overinvestment of personal funds, and having a good back-up plan are all great ways to maintain the perspective you need to make sound business decisions every day.