Many entrepreneurs start their first business as a sole proprietorship. It’s typically the easiest business structure to form. However, it also leaves the owner financially vulnerable if the business is sued or accumulates debt it can’t pay.
Sole proprietors often find themselves using personal funds to finance their business when they run into a liquidity issue and have to pay employees or vendors or purchase equipment or supplies. They may end up moving money back and forth between their personal and business accounts.
Doing that in a corporation or company with another type of business structure that protects officers from personal liability can be a breach of fiduciary duty. However, that’s not the case for sole proprietorships.
Nonetheless, sole proprietors should scrupulously separate their personal and business finances. Why?
Commingling personal and business funds can bring complications
When you avoid commingling personal and business funds, you minimize the chances of making a costly tax error. Separating your personal and business finances and transactions will also make your financial statements much clearer and more accurate.
If you use a tax preparer and/or accountant, you’ll make things less complicated for them – and less expensive for yourself. Having clearly separate financial records will also help when you apply for a business loan.
Avoiding commingling requires some extra steps
Sole proprietors often commingle personal and business assets to simply save a couple of steps. They may just deposit a client’s check directly into their personal account to pay themselves. However, that check should go into the business account. Sole proprietors should then pay themselves out of that account. That’s just one example of how to avoid this commingling.
No matter what type of business you’re starting, it’s crucial to understand the potential legal ramifications of commingling personal and business funds. Having sound legal guidance from the beginning can save you time, stress and money in the long run.