When it comes to your finances, mixing business with pleasure can have serious consequences. Make banking and bookkeeping a breeze, however, when you keep your corporate cash out of your personal pocketbook.

By: MATT ALDERTON

After living for 40 years in Chicago, event planner Kathy Donnell and her husband moved to Colorado in 2003 in pursuit of a change of pace. They found it amid the high altitude and the crisp Rocky Mountain air. They also found it, however, on the face of an unexpected check.

"My original intention when I moved to Colorado was to freelance for other companies," Donnell explains. She wasn't busy, so when a friend of hers had the opportunity to pursue a large long-term contract, she was more than willing to help him write his proposal. "We had never discussed money, but when he was awarded the contract I got a five-figure check from his accountant. His accountant didn't put my personal name on the check, though; he put 'Donnell Meeting Management' on it."

Unfortunately, there was no such thing as Donnell Meeting Management. It didn't exist. Anxious to cash the check, however, Donnell nonetheless decided to open a checking account at her local bank under the faux business' name.

On her way home from the bank, a former associate called to offer Donnell work. A few days later, another associate called for the same reason. The timing was perfectly orchestrated.

Excited, Donnell decided to run with her newfound opportunities, going so far as to even hire an assistant. Within a matter of five days she had started her own event planning business, Donnell Meeting Management—all because of a surprise, miswritten check.

"This little windfall started it all," she says. "It was kind of serendipitous."

While a bookkeeping error may have started Donnell's business, it's bookkeeping caution that's kept it running. After all, her company had its own bank account from day one, and Donnell has deliberately kept her money separate but equal ever since—just in case.

It's easier that way, Donnell says. More than that, though, it's smarter, as keeping your business and personal finances separate reduces your risk of an IRS audit and increases your opportunities for accurate, business-building forecasts. It's good banking, and it's good business, too.

Separate Spells Success

Like Donnell, most small business owners can trace their company's financial philosophy to its roots, according to Shana Murphy, a partner in K&M Financial Services, a Portland, Ore.-based company that specializes in small business finance and accounting consulting.

"A company that grew into its own from a personal hobby most likely has business records mixed in with personal records because it was not necessarily the owner's intention to become a traditional business," she says. "A business that was started more intentionally generally has more thought go into it from the front end and thus often begins as a separate entity."

No matter how your business got its start, however, Murphy suggests that separating business and personal finances is critical to its future success. That's because having separate ledgers makes taxes easier and business planning more effective.

"There are different tax laws and deductions available for your business finances versus personal finances," Murphy says. "Keeping finances separated from the beginning saves both time and sanity come tax season."

Indeed, commingling one's finances increases the odds of making mistakes on your tax return and decreases the odds of surviving a potential IRS audit. It also increases your accounting costs, as accountants and bookkeepers tend to charge more to manage unkempt accounts than they do tidy ones.

"Keeping finances separate also demonstrates the true performance of your business and can help you to make crucial business decisions," Murphy continues. "For instance, if you keep business finances separate, you would be able to determine that advertising is 50 percent of your expenses and dramatically reduces your net income. With that knowledge, you might choose to reduce your advertising budget or try different advertising mediums to reduce your expenses to a more reasonable 30 percent."

To that end, having separate business books enables you to build detailed profit and loss statements and make accurate revenue forecasts, which are invaluable in the smart cash flow analysis that keeps many companies afloat.

Making the Cut

If you're ready to cut your business loose from your personal accounts, you should know that "separate" means different things for different business structures. If you're incorporated, for instance, the line between your money and your business' money is necessarily rigid. If you're a sole proprietor or an LLC, however, the line is more permeable.

No matter your structure, however, there are a few simple rules that every business should follow, according to Murphy. First, you should always have separate credit cards and checking accounts for business and personal use. Second, you should use accounting software to track and categorize business expenses. Finally, you should hire a financial advisor or a bookkeeper to keep tabs on your everyday business transactions.

"If you are mid-year, go back and assemble all of your receipts for expenses and billings," Murphy advises. "If you do not have these, go through your check register and credit card statements and highlight everything related to your business. Then, using either Excel or accounting software, enter all of the relevant information. It is as easy as that. If you are ready to separate at this point, then go ahead and open up new business accounts, with your records up to this point as the opening balances."

Separation Anxiety?

If you're not yet ready to isolate your business transactions from your personal ones, you're probably scared, according to Murphy. And that's OK. "Often, it's a fear of the unknown that leads a business owner to keep everything together," she says.

If that's the case, then do as much research as you need to do in order to get comfortable with the idea and the mechanics. It might help, for instance, to know that having money in your business accounts doesn't mean you're forbidden from spending it on personal expenses. "If I need money personally," Donnell says, "I take a draw from my business account and deposit it into my Kathy Donnell personal account. It's no big deal."

And if you just plain don't want to make the separation? "I would not recommend it," Murphy says, "but as long as you are able to track your business and personal finances separately, it would be OK to commingle the dollars in the same account."

If you do commingle, Donnell and Murphy agree, the key to success is organization. Keep all your receipts. Make detailed notes in the "Memo" field of all your checks. Generate invoices for all billable income and never throw away a bank statement or a credit card bill. If you stay on top of your money, the IRS will be more likely to stay off of it.