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Managing Your Money: The Importance of Separating Personal and Business Finances

Aug 11, 2024

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Separate Personal and Business Finances

Separating personal and business finances

Are you self-employed or a small business owner? If so, separating your personal and business finances is critical to financial success. Let's break it down and make it easy for you to take control of your money.


I know managing finances can be a complex task. One common practice that can lead to confusion and financial stress is combining personal and business finances.


When personal and business finances are mixed together, it's difficult to see how profitable your business is and to know if you are making the right decisions for it. Questions like "How much money do I need to put aside for taxes?" and "Where is the money going?" often go unanswered, leading to frustration and uncertainty.


My goal is to help you get clarity around your money. If you are self-employed or a small business owner, this starts by separating your personal and business finances. Let's break down the following three steps.


  • Separate Personal and Business Accounts

  • Establish a regular paycheck from your business

  • Estimate and plan for taxes


Separate Personal and Business Accounts

First, open a separate checking and savings account for your business. This will help you keep track of business transactions and avoid using personal funds for business expenses. Keep receipts for business expenses for tax purposes.


For example, we will help Murphy figure out their paycheck amount, how often they will get paid, and how much to set aside for taxes. Now that Murphy has their new business checking and savings account setup, let's figure out how much their paycheck should be.


  • Murphy's monthly expenses total $3,000, and savings total $500, totaling $3,500 monthly. The expenses include mortgage or rent, utilities, internet, insurance, mobile phone, groceries, eating out, pet, kids, and medical. On the savings side, this amount includes savings for quarterly payments, travel, holidays, and more.


Tip: Get an envelope and label it with the month to keep track of your receipts. If needed, make multiple envelopes to keep in convenient locations (office, vehicle, backpack/workbag, etc.).


Establish a Regular Paycheck from Your Business

Next, it's time to establish a regular paycheck from your business. Calculate your monthly personal expenses and savings, decide on a fixed amount your business will pay you regularly, and transfer it to your personal account per the schedule.


This way, you can take care of your personal expenses and keep your business finances in check at the same time. It's the security of knowing you have enough money to pay for your personal stuff, and it also gives you the power to make smart choices about your business using any extra cash you have left over.


Let's continue with Murphy, who has total personal monthly expenses and savings of $3,500.


  • Murphy has another $1,500 in income to pay for expenses. This income could come from another type of business, a significant other, a roommate, a part-time or full-time job, savings, etc.

  • Murphy determines that they need to pay themselves $2,000 monthly from the business to cover their total monthly expenses and savings.

    • Monthly Expenses and Savings $3,500 - Other Income $1,500 = Paycheck $2,000

  • Murphy decides to pay themselves twice a month: $1,000 on the 1st and $1,000 on the 15th.


Note: Murphy can determine their pay schedule. They could decide on $500/week, $1,000 twice a month, or $2,000 once a month. Adjust the bank transfer schedule accordingly.


Estimate Tax Payments and Plan for Filing Taxes

When separating personal and business finances, figuring out your tax bills and planning when you must pay them is important. Get a handle on what taxes you owe, keep good records of your money, and set aside some of your business income just for taxes. That way, you won't have any tax headaches later on.


To make things easier, you can talk to a tax expert who can help you figure out how much money you should put aside for taxes from your business. Then, add that amount to your business savings account (or open separate savings just for taxes) and keep adding to it until the next tax payment is due.


Let's continue with Murphy, who will pay themselves twice a month: $1,000 on the 1st and $1,000 on the 15th.


  • Murphy calculates an estimated tax payment based on their paycheck amount. In this example, Murphy will use a 25% tax rate. $1,000 x 25% = $250.

  • Murphy makes the following two bank transfers on the 1st and again on the 15th:

    • 1st and 15th of the Month Paycheck: Transfers $1,000 from business checking to personal checking account as paycheck amount needed to cover monthly expenses.

    • 1st and 15th of the Month Tax Payment: Transfers $250 from business checking to business savings account for tax payment


Benefits of Having Cash Flow Clarity

So, why is it important to separate personal and business finances? Separating your finances gives you a clear picture of your business's revenue and expenses, allowing you to make informed decisions about investments and cost-cutting. This clarity eliminates the stress of mixing personal and business finances and ensures stability in your business and personal life.


Taking control of your business finances doesn't have to be daunting. By following these simple steps, you can achieve clarity in your finances and make confident decisions for the future of your business and personal life.


Murphy knows their monthly revenue target, which will cover their $2,000 paycheck, $500 tax payment, and other business expenses.


Reflection Question

Before making informed decisions about your business, keep your personal and business money separate.


  • What's something you wish you knew more about when it comes to your money?

  • How would it feel if you had a better understanding of this part of your finances? How would that knowledge help you make decisions about your money?


What do you think?

If you have any questions or comments, I would love to hear from you! Leave a comment below or send me an email at hello@moneycoachjessica.com.

Also, I would love for you to share this with someone you know who may find this helpful.


 

Summary Bullet Points

Open Separate Bank Accounts:

  • Open a separate checking and savings account for your business.

  • Use the business account exclusively for business-related transactions.

  • If you use credit cards, follow the same process. Use one credit card for business expenses and another for personal expenses.


Track Transactions Separately:

  • Avoid using personal funds for business expenses and vice versa.

  • Keep receipts for business expenses for tax purposes.


Determine Your Personal Expenses:

  • Calculate your monthly personal expenses (rent/mortgage, utilities, groceries, dining out, entertainment, shopping, travel, savings, credit cards, etc.).


Set a Consistent Paycheck Amount:

  • Decide on a fixed amount that your business will pay you regularly (e.g., weekly or monthly).

  • This paycheck covers your personal expenses.


Transfer Funds to Your Personal Account:

  • Transfer the paycheck amount from your business account to your personal account based on the schedule.

  • Treat it like a salary to maintain discipline.


If you have remaining net profit, you will need to decide how to use it (e.g., invest in the business, invest in training, pay yourself a bonus, etc.).


Understand Your Tax Obligations:

  • Keep good financial records.

  • Factor in federal, state, and self-employment taxes.

  • Consult a tax professional to determine your estimated quarterly tax payments.

Tip: You do not have to wait until tax season to find a CPA - start now!


Allocate Funds for Taxes:

  • Set aside a portion of your business income specifically for taxes.

  • Tip: Create a separate savings account for tax payments.


Profitability Insights

  • You can see your business's revenue and expenses with separate accounts.

  • If you offer multiple products or services, know the profitability of each.

  • How to calculate Profitability:

    • Gross Profit = Revenues - COGS

    • Operating Profit = Revenues - COGS - Operating Expenses

    • Net Profit = Revenues - COGS - Operating Exp - Taxes - Interest


Strategic Decision-Making

  • Make informed choices about investments, expansion, or cost-cutting based on accurate financial information.

  • Implement Key Performance Indicators (KPIs). KPIs help small business owners track progress, make data-driven decisions, and evaluate business strategies.


Peace of Mind

  • Eliminate the stress of commingling finances and ensure the stability of your business and personal life.

  • Have more time to do the things you enjoy, professionally and personally.

Aug 11, 2024

5 min read

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13

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