Estimated reading time: 6 minutes
In a certain sense, your business is a very personal thing. Especially if you’re a sole owner, your business is a manifestation of your vision, beliefs, values — not to mention hours upon hours of work.
So it’s normal to see your business as an extension of yourself, or to feel like you are your business.
I find this is especially the case for solopreneurs, like coaches, music teachers, artists, freelancers, etc, where you are the face of your business. It’s hard to keep those lines from blurring.
And yet, you aren’t your business. Even if your business shares the same name as you, your business still needs to be its own entity, for both legal as well as practical reasons.
A big part of that includes not commingling your own finances with those of your business.
What’s the big deal, though? What’s it matter if you treat your business as an extension of you?
Is It a Hobby or a Business?
One serious question you have to ask yourself is, is this endeavor a business, or just a hobby?
They can look very similar on the surface. A hobby is something you do in your free time, and it might even make a bit of money here and there.
And similarly, your business, especially when starting out, may also be something you do in your free time, and you may not be making a lot of money in the beginning.
But the distinction is crucial. A hobby is something you do for fun, and whether or not it makes money is secondary. Indeed you might pour significant amounts of money into it without any consideration of return.
But a business is different.
Of course, it should also be enjoyable to you. But you have an obligation to your business: to prioritize making a profit. Without a profit, you don’t have a business.
Now your goals should obviously align quite a bit. You, too, want your business to make a profit, so it can pay you and provide you with the life you want. Indeed you could say your business has an obligation to you, too: to fairly compensate you for the time and energy you put into the business.
But the money the business pays you is actually secondary. The primary goal is to make a profit for the business, and then to use those profits in the most efficient way to help the business grow.
I’m not just pulling this out of thin air, either. The IRS defines a business as any activity that has the “intention of making a profit”, among other factors (nine in total).
In fact, if your business hasn’t made a profit for at least three out of the last five years, the IRS will by default consider it a hobby.
And if it’s considered a hobby, then you can no longer claim those business expenses as deductions, nor can your losses offset any other income you might have.
Your Goals Are Similar But Not Identical
Now again, of course if your business is profitable, then you, by extension, are profitable as well. So it would seem the distinction is immaterial. But let me give some examples to illustrate why it matters.
Let’s say you have paid all your business expenses for the month and still have $5,000 left over.
You could choose to pay that entire $5,000 to yourself as an owner’s distribution. Or, you could take $1,000 of that and reinvest it into the business to help it grow even more — say running a marketing campaign to attract more customers, or upgrading your website.
Does the business prioritize paying you as much as possible, or using some of those profits to grow? That’s a decision that has to be made from the business’s perspective, not your own.
The bigger the business gets, the more this distinction matters and the more important it is to see it as a separate entity. Eventually you might have other considerations like employees, or even other investors/shareholders. And maybe eventually, you might have to make the business attractive to a potential buyer.
Important Even for Solopreneurs
But even if you will only ever be the sole employee and owner of your business, it’s still important to treat it as a separate entity.
For one, one of the nine factors I referenced above from the IRS is that you conduct your business “in a businesslike manner”. This includes keeping detailed books, records, and the like for your business, as distinct from your personal finances.
If they see that you are commingling personal and business funds, they could consider that you’re not running it as a business and so label it as a hobby and disallow business deductions.
Also, if you ever plan on registering it as an LLC or corporation in order to protect your own personal assets (you almost definitely should do this no matter the size of your business), keeping that distinction is vital, or else you could be putting that limited liability at risk.
If you ever get sued by a customer, for example, you definitely want to have that distinction between you and your business. Otherwise courts could hold you personally liable. This is called piercing the corporate veil.
The Importance of Separate Accounts
The best and most fundamental way to treat your business as a separate entity is to stop commingling personal and business finances by opening separate accounts for your business.
When you have that clear dividing line between your personal and business funds, it’s easier to distinguish your own personal goals from those of your business.
You know exactly what money belongs to your business and what money belongs to you, and the decision to pay yourself a given amount is a far more deliberate decision, requiring writing a check or performing a bank transfer.
When you’re looking strictly at your business’s finances, you can step into the role of CEO and make decisions best for the business. How much profit do you want to reinvest vs. withdraw as the owner? What decisions do you need to make to help the business grow?
Not to mention, it’s far, far easier to keep accurate books, since personal expenses aren’t muddying the waters. You can see exactly how much profit you made in a given period, and exactly how much revenue your business is bringing in.
Having those accurate numbers allows you to make more informed decisions that allow your business to grow even more.
Plus, as the owner, you can clearly see how much money you have contributed into the business vs. how much you have withdrawn. You will see the exact moment your business moves from being a drag on your personal finances, to actually contributing to your financial freedom.
If you mean to run a business and not merely pursue a hobby, it’s vital that you immediately open a business bank account and start running all your expenses through there. This will help you to prevent commingling personal and business finances and make it easier for you to keep accurate books.
If you’re not sure how to get started, reaching out to a qualified bookkeeper can help you gain the clarity you need to make decisions that are best for both you and your business. Click the link below and let’s discuss how I can help.