If you’re getting into business for yourself, say through ride sharing, freelance work or selling products online, you’re likely starting to take business cash flow seriously. Your personal finances and business finances may be intertwined right now as you build up your gig work or side hustle. That’s likely true when it comes to your credit and business, as well.
However, if you’re going to pursue your small business long-term, it’s a good idea to start creating distance between your personal and business expenses. Not only can it help make managing your money easier, it’s a necessary step to start developing your small business credit.
Below are some things to keep in mind when it comes to small business credit and finances as you continue down your entrepreneurial path.
Keep personal and business finances separate
Many self-employed entrepreneurs pay for their small business’ expenses with their savings and personal credit cards when they’re just starting out. This is common with sole proprietorships, when someone owns and runs an unincorporated business by themselves. As a sole proprietor, business expenses are your own expenses and business income is your income. You can read more about the pros and cons of sole proprietorships on the U.S. Small Business Administration’s webpage.
As a sole proprietor, even though you’re personally responsible for business expenses and income, you should still keep thorough records of business-related transactions. This can make it easier to clean up your accounting each month, and especially at tax time.
Is my personal credit linked to my small business?
It may be, especially if you’re just getting your business off the ground. Your personal credit history is reported by three main credit reporting agencies: TransUnion, Experian and Equifax. Business credit is reported by Dun & Bradstreet, Experian and Equifax, among others. Personal and business credit scores are based on different transaction histories.
With a sole proprietorship, you’ll likely be relying on your personal credit. That’s because with a sole proprietorship, you don’t have an Employer Identification Number, which is what the credit reporting agencies use to create a business credit file.
If you’re using personal credit cards for business expenses, the growing balance can count against your personal credit utilization rate. This is how much of your available balance you’re using at any one time, and it’s one of the major factors in credit score calculations.
When you apply for a small business credit card or loan as a sole proprietor, lenders will likely look at your personal credit history. Essentially, the lenders will be asking for a personal guarantee from you as an individual that you’ll pay back the funds. This may result in a hard inquiry on your personal credit report, which can impact your credit score.
Get ahead of this by checking your credit report before applying. It’s easy to do, and through April 2022 you can get a free weekly credit report from each of the three main credit reporting agencies. Check out our guide to how to read your credit report if you have questions as you review.
Beyond the initial inquiry, some lenders may also report activity for your small business credit card, like your balances and payment history, on your personal credit report. This isn’t always the case, but you can ask your lender about their small business credit card reporting practices.
If you use a small business credit card, it’s smart to follow best practices you would with a personal card. Make all your payments on time and try to keep your balances low. This can help keep your business card from negatively impacting your personal credit history.
Your small business credit can grow as your business does
As your business grows, you may consider creating a more formal business structure like a limited liability corporation (LLC). When you do, you’ll receive an Employer Identification Number, which is one of the first steps in separating you from your business. It also allows you to open a business bank account and build business credit, which can open opportunities for additional funding, like small business lines of credit.
You may not have grand plans to create a multifaceted, major corporation beyond a side hustle or limited gig work. And that’s perfectly fine. But even if you’re making modest income on the side, it may be worth it to establish your business as its own entity. It can help you manage your cash flow, allow you to build business credit and could be the boost you need to take your business to the next level, should you desire.
If you’re using your credit card more lately, read our blog post to learn how it can impact your score, along with smart habits to maintain healthy credit.