Why should you keep your small business and personal credit separate?
After the 2008 financial crash, it has been increasingly difficult for small business owners to get the credit they need to smooth over blips in cash flow, purchase new stock or assets, or budget for growth. This is particularly true in business areas traditionally regarded as risky by commercial lenders.
As a consequence, many small business owners have thought laterally and instead obtained personal credit to gain the finance they need. This decision can have serious – and very adverse – consequences.
First and foremost, by doing this you expose yourself to significant personal liability if your business runs into financial problems: you won’t be able to walk away with your personal assets intact and start again. Equally, if you avoid bank loans in your personal capacity and opt to borrow from family and friends you can seriously damage these relationships if you find yourself unable to repay on time and in full. What’s more, lenders will access your personal financial information each time you wish to borrow: over time, this can have a negative (if admittedly small) impact on your credit rating.
With business finance, you can borrow a lot more
If you can establish a strong credit profile for your business, you may be able to borrow a great deal more than you could as an individual – anything from 10 to 100 times as much. This is an important factor, as on average a business owner uses 10 times as much as credit as a consumer. In short, running a business using personal credit alone can be virtually impossible, even aside from the factors mentioned above.
What’s more, separating business credit makes it easier to identify tax deductions, thus ensuring that you pay the minimum legal amount of tax. In addition, a business loan is more likely to set out clear expectations and deadlines for repayment, which will force you to think effectively and use the money wisely.
So what steps should you take to separate your business and personal credit and start making business finance work for you?
How to separate your finances
The first, and most obvious, step is to establish your business as a separate legal entity, whether a limited company or limited liability partnership. Your accountant should be able to advise on the best structure for your situation and from there it’s simply a question of filling in some fairly basic paperwork, the bulk of which can be completed online.
Having done this, you should then set up a separate current account for the business. This will usually involve a meeting with your bank’s Small Business Adviser, which is likely to take less than an hour. This account can be used for all business-related expenses, with payment to yourself being transferred into your personal account.
It is important that your business quickly builds up a credit score, which is easily achieved by obtaining a business credit card and ensuring that repayments are made on time and in full. However, be careful not to spend up to your limit, as this is likely to have an adverse effect on your score.
At the same time, you should establish lines of credit with your vendors and suppliers. These agreements will establish the amount of time you have to pay (usually 15, 30 or 60 days), giving you some extra breathing space if your cash flow faces a hurdle. Consistently pay on time or early and your credit score will improve, enabling you to negotiate more credit and better payment terms.
In the longer term, it is important to stay on top of your credit score: a survey in the States, conducted by the US Small Business Administration, discovered that this can decline drastically in as little as three months. For this reason, lenders and creditors will regularly reassess your creditworthiness, and you could quickly find yourself facing unfavourable payment terms that could significantly affect your cash flow.