A 2015 survey from Citizens Bank found that 26% of small business owners use a checking account for both business and personal finances. Those sole proprietors, who file on Schedule C, mistakenly think that it is easier to use a personal checking account that’s already in place to manage finances, especially if there aren’t too many business transactions.

Consider the following scenario; a contractor stops at Home Depot to pick up supplies for a job but uses money from his/her personal account to cover it. To do it right, this cost needs to be recorded as an accounting transaction – and that’s when things start to get complicated.

There are several key reasons for using separate accounts for personal and business income and expenses.

1. Streamline recordkeeping at tax time. Keeping track of business income and expenses oftentimes happens once a year in February or March (or later) when it comes time to prepare your taxes. When clients use one checking account for their personal and business expenses, in my opinion, the amount of time spent digging through receipts, bank statements, credit card statements, and other records is significantly more than if the accounts were separated in the first place. Additionally, the accuracy of capturing all income and expenses will be significantly higher, in my opinion. After all, who remembers whether or not a purchase on Amazon several months ago was for the home or the office.
2. Understand business net income and cash flow. Oftentimes, when I speak with sole proprietors, I ask them, “About how much net income has your business made so far this year?” For those who don’t know the answer, the task of projecting their income tax expense is that much more difficult and time-consuming. Even something simple as knowing what cash was in the bank at the start of the year versus what the balance is in the account today can give you some idea of how much money you have made if you have a dedicated business bank account.
3. Building a business credit profile. Most small business owners I know rely on their personal credit and assets to fund the business because banks won’t consider offering credit or a loan to any entity that doesn’t have a credit history. Additionally, using a business credit card shrewdly for business expenses only helps to increase the business credit card limit with the additional benefit of lower interest rates in the future.
4. Limiting audit scope. In the unfortunate circumstance that you are selected for audit by the IRS, the first thing the IRS will ask for is a copy of your bank statements. Many correspondence audits only focus on one area of your return – usually just the Schedule C for sole proprietors. If only your Schedule C is chosen for an audit, separate finances will make for a less painful audit because who really wants to submit their personal financial information if they don’t have to? Additionally, separate business and personal accounts lend credibility to the fact that your business is, in fact, a “going concern” engaged in “for-profit” and not a hobby.

In summary, all sole proprietors should set-up dedicated checking, savings and credit card accounts for the business and use them only for business-related expenses. When it’s time to file the tax return, it will be much easier to identify all activities. You will have a better understanding of the cash flow of your business. You will also develop a business credit profile and if you are audited, you will help limit the scope of the audit.