Separating Personal and Business Financials for Small Business Owners: A Key to Successful Valuation and Sale
As a small business owner, you might think you can manage business and personal finances in the same account. But if you’re considering selling your business now or in the future, this approach can impact your valuation and complicate the sales process.
One busy month of not reconciling turns into two, and suddenly, your personal bank account is a chaotic mix of personal and business expenses. This financial tangle not only makes it difficult to track your business’s economic health but can also raise red flags for potential buyers and potentially cause legal and tax issues.
Even as a small business owner with no immediate plans to sell, it’s in your best interest to open a business bank account for all your business transactions. This separation will make your business more attractive to future buyers who want to see clean, clear financial records.
Benefits of Separating Finances
Separating finances goes beyond organization. It also has the following key benefits, particularly when preparing your business for sale:
Improved Financial Tracking and Reporting
Keeping your personal and business finances separate simplifies financial tracking and reporting. It’s much easier to keep track of your business’s cash flow, expenses, and profits since all transactions in a business checking account are business-related. This clarity is important when valuing your business or presenting financials to potential buyers.
A dedicated business account can also connect more readily to accounting software, providing the detailed financial reports that buyers will want to see.
Legal Benefits and Compliance
Maintaining separate accounts can protect you legally. For example, if someone ever sues your business, having a separate business account clearly demonstrates that your business is a separate entity. This separation can provide legal protection for your assets, which is particularly important if your business entity is a limited liability company (LLC) or a corporation. It also reassures potential buyers that they’re purchasing a distinct business entity.
Enhanced Credibility and Business Image
A dedicated business account appears more professional to vendors, financial institutions, and potential buyers. It shows that you are serious about business operations. This can be vital when seeking business loans, applying for a line of credit, forming partnerships, or negotiating with prospective buyers.
Tax Preparation
When tax season arrives, you’ll be grateful for separate accounts. Going through transactions in a mixed account is time-consuming, increases the chances of errors when filing taxes, and can potentially lead to audits. On the other hand, it is quicker and easier to account for all tax deductions with clear records.
Clean tax records are a huge selling point. Buyers want to see a clear tax history that reflects the true performance of the business they’re considering purchasing.
Business Valuation: Tax Implications of Mingled vs. Separated Finances
A tax audit by the IRS is a nightmare you want to avoid at all costs. Although there’s no guarantee you’ll never get audited, mingling personal and business expenses can increase the chances. Maintaining separate accounts makes you more compliant with tax laws, and you can take full advantage of business write-offs.
When it comes time to value your business for sale, separated finances make it much easier to demonstrate your business’s true profitability. This clarity can impact your valuation and make your business more attractive to potential buyers.
The Role of Business Structure in Financial Separation
The structure of your business plays a significant role in how you manage your finances.
While you’re legally allowed to use a single account as a sole proprietor, separating finances is still advisable for tracking and reporting.
However, because an LLC provides personal legal protection, personal and business accounts must be separate to maintain this protection.
Corporations are held to different standards altogether. They are legally required to keep finances separate to uphold the corporation's legal status and protect shareholders.
Steps to Separate Finances
Separating finances can seem daunting if you’re a new business owner or already have one account for personal and business expenses. However, following these steps can make the process easier.
- Open a dedicated bank account for your business and use it solely for business income and expenditures.
- Apply for a business credit card exclusively for business purchases. This will help build your business credit score and keep your personal credit separate.
- Set up a bookkeeping system with accounting software like QuickBooks, Xero, or Wave, or hire a professional bookkeeper.
- Establish a regular salary or draw for yourself Instead of using business funds for personal expenses. It’s important to compensate yourself and maintain clear boundaries between business and personal finances.
- Create and maintain a system for organizing and storing receipts and financial records. Whether you use digital tools or physical filing systems, keeping your records organized is critical for accurate bookkeeping. You’ll be thankful during tax time and if you ever decide to sell your business.
- Regularly review your financials with an eye toward your future sale. Ask yourself, “If a buyer looked at these books today, what story would they tell about my business?”
The Impact of Mixed Finances on Business Valuation
If you sell your business someday (you may not want to now, but operate as though this might change), maintaining separate business and personal financial records will make assigning a value to your business easier.
Imagine going through years of jumbled finances, knowing all you had to do was manage separate accounts from the beginning. Of course, accurate recordkeeping plays a role in this as well.
If you’ve mixed your finances, here are some strategies to improve your business valuation.
- Recasting Financial Statements: When preparing for a sale or valuation, recasting financial statements involves adjusting the financials to reflect the actual economic performance of your business. This process removes personal expenses and non-recurring items previously mingled with business finances.
- Add-Backs: These are financial statement adjustments to account for certain expenses not expected to continue after the sale. These typically include personal expenses, discretionary spending, and non-recurring costs.
- Seller Financing: This is when you (the seller) loan money to the buyer to finance the purchase of the business. You’d most likely receive regular payments over time instead of a lump sum upfront.
- Professional Valuation: Consider hiring a business broker or professional appraiser. They can help you present your financials in the best light and potentially identify value you might have overlooked.
Financial Documents When Selling a Business
Preparing comprehensive and accurate financial documents facilitates the due diligence process and builds credibility with potential buyers. Transparency and organization can lead to a smoother transaction and potentially a higher valuation for your business.
Here are the documents you should have prepped and ready to sell your business.
- Profit and loss statements for at least three years
- Balance sheets for the past three years
- Cash flow statements for the past three years
- Copies of federal and state tax returns for the past three years
- Detailed accounts receivable and payable
- Inventory reports with current inventory reports, if applicable
- A register of all fixed assets, including equipment, vehicles, and property, along with their depreciation schedules
- Bank statements for the past year
- Details of any outstanding loans or debts, including terms and repayment schedules
Get Your Business on the Right Track
Separating personal and business finances is important for any small business owner, especially if you’re considering selling your business in the future. It simplifies financial management, protects personal assets, enhances business credibility, and ensures legal and tax compliance. Most importantly, it sets you up for a smoother, more profitable sale when the time comes.
Consider getting professional advice from a business broker or CPA to learn more about managing your business finances with an eye toward eventual sale. They can provide invaluable guidance and help you set up your business for long-term success and maximum value.
Start your business on the right track today by keeping your personal and business financials separate and organized. Then, unlock your business’s true value with BizBuySell’s valuation tools. From quick estimates to in-depth analysis, we’ve got you covered at every stage of your selling journey.