As a limited company, your business and personal finances must be kept apart as the business is considered to be a separate legal entity. However, as a sole trader, there is no legal distinction between you and the business. This means all profits, losses and liabilities are tied to you personally.
The importance of separate finances
This responsibility and overlap between yourself and your business makes it all the more important to keep finances apart. It is also important to keep track of finances within the business often through audits, bookkeeping and your tax returns.
You should set up a different bank account for your business. This way all transactions are independent and it is easier to keep your personal money and your business money away from each other. If business transactions are going out of your personal bank account, it means things quickly get messy and undistinctive.
This approach is also applicable to credit cards. If you have a personal credit card and you feel like you may need one for your business then you should apply for a business credit card. Again, this keeps purchases and monies separate making it easier for you, as the business’ owner.
There are some things to keep in mind when deciding how to deal with your business and personal finances as a sole trader. These include:
You may end up paying the wrong amount of tax
Keeping all your finances together makes it a lot more difficult to see which purchases, incomes and transactions belong to you and to your business. As a result, it can be a lot more problematic, come tax return time, to figure exactly how much tax you and your business owe.
Whether you work out your own tax or have an accountant do it, it is easy to make mistakes. These mistakes could end up in you or your business paying too much tax, or not paying enough which could result in fines.
Having separate accounts simplifies the process ensuring you pay the correct tax personally and business-wise.
You have better control over your business and personal cash
The cash for your business and your own personal money is a lot safer in accounts that are not connected. Money from your personal account will not be spent on your business unless you choose to do this. You’ll be able to keep a closer eye on your own personal finances this way. As well as, making sure your money doesn’t get lost within your business.
In terms of business cash, it will be simpler to budget how much you have to spend on product development and marketing campaigns. You’ll be able to see exactly how much profit you have made monthly and annually at a glance.
Running your business, along with your household and personal spending budget, is much less difficult when you have this safety net for your finances.
It is much more professional
Managers of businesses are usually deemed to be much more professional and organised by many when they have a different bank account for business finances. A lot of people may ask if your business is a hobby or a serious business venture. One of the best ways to show people how serious you are, especially banks and lenders, is to have a standalone business account.
If your business was just a hobby, on the side of your day job, having a separate account may not be necessary but is good practice. However, when you decide to take your business full time, you need to be more serious about the cash involved.
The more professional you appear from the outset, the more likely you are to be respected and thought of as business-like by other businesses, peers and banks.
You may only be a sole trader in a small business but you should still treat your business finances like that of a limited company. It will make running your business more straightforward for you in the long run should the worst ever happen.