Why Mixing Your Personal and Business Finances Is a Bad Idea

Entrepreneurs, whether they’re serial business starters or pandemic-prompted newbies, often use their personal finances to start their business without opening a separate bank account. Some want to try out their business idea first, while others aren’t sure if they need another bank account for their side gig. Similarly, those who work as independent contractors may not have considered the implications of co-mingling funds.

If your business idea starts to generate increased expenses and income, then the lines between personal and business begin to blur. If you often wonder where your money is hiding, then it's probably because you’re not keeping your business finances separate from your personal cash. Here are a few tips for avoiding financial mistakes that could cost you down the road.

The Difference Between Personal Accounts and Business Accounts

With side hustles, freelancing, and self-employment increasing during the pandemic, there's a lot of gray area when it comes to managing finances. Studies show that 15 percent of Gen Z and 10 percent of millennials aren’t confident in their financial future. So, it’s important to learn how to properly manage your finances in order to avoid unnecessary risks, audits, and accounting mistakes.

For most people, a personal account, such as a checking or a savings account, can be used to deposit and withdraw money. A personal checking account is all you need to manage your payments and expenses if you don’t own your own business.

But there are occasions in which you might need to open a business account as well. As a general rule of thumb, if any part of your income comes from revenue earned from selling products and services, then it is a good idea to keep your personal and business finances separate.

Business accounts typically offer extra features, such as a credit card account or merchant services account, as well as different loan options. Among other things, this allows business owners to accept transactions from their customers.

Even if you receive payments primarily from digital channels, setting up a business account is still one of the necessary steps for any freelancer, even if you’re just generating extra income on the side. Co-mingling of funds presents a unique set of financial problems that can wreak havoc on sole proprietors and independent contractors, particularly at tax time.

Reasons to Keep Personal and Business Finances Separate

Having accurate records is really important when operating a side hustle, but especially when it comes to taxes. Taxes can be strange and confusing for the best of us, but it’s even more challenging for business owners.

As a freelancer or self-employed person, you will have to itemize your expenses and income. Itemizing your deductions accurately can also help you save some money on taxes. But any mistakes could have you sending more money to the Fed than necessary, as well as put you at risk if you are subjected to an audit.

Sometimes blurring the lines between business and pleasure is permissible: 31 percent of remote workers use the bed as their main workspace, for example. But this is not the case when it comes to finances. It can be easier to overspend when the funds from your business are conveniently located in your personal bank account.

And, if your business goes under or someone sues your company, you could be held personally responsible if your finances are not distinct. Forming an LLC helps keep business liability and personal liability separated, so that if the worst does happen, you can still eat and pay rent.

In addition to business insurance, having a good life insurance policy can allow you to have peace of mind knowing your family’s future is financially secured. Despite its importance, only 52 percent of Americans report holding life insurance policies. Canadians are even less insured with only 33 percent of surveyed adults reporting having a life insurance policy in place.

Everyone’s financial needs are different, so it's important to check with a financial advisor to ensure that you’re covered.

Bottom line? To avoid legal headaches, it's crucial that side hustlers, independent contractors, and freelancers keep accurate records of their earnings and expenditures throughout the year. If you’re generating income outside of your 9 to 5, or you’ve replaced your 9 to 5 with your own gig, you need to have a bank account that’s strictly for keeping track of money coming in and going out of your business. Separating your finances is an important step towards planning for retirement and protecting your financial future.