Small business guide to accounting

There’s nothing more exciting in life than chasing after your dreams. For many, that means taking something they love and turning it into a business.

Accounting may not be the most thrilling part of that journey, but it certainly becomes one of the most important. It might seem a lot to take in at first. However, if you get to know the basics, and with a little help from technology, we believe you’ll be able to manage.

This article will help you understand some basics about accounting and how it can help your new venture thrive.

First, we should understand why accounting is so vital.

As a small business owner, it’s down to you to stay within the rules set out by HMRC when it comes to paying and reporting the various taxes. It’s also your responsibility to make sure you don’t pay more tax than you need to.

Many small businesses make the mistake of not worrying about it until their tax return is due. Do this and you’ll have to comb through your transactions for the whole tax year, remembering which ones were allowable expenses and which invoices were paid. By being on top of your accounts from the very start, this process becomes much simpler.

But there are other benefits to well-organised accounting. It’s also really useful in helping you assess the health of your business. With a regular ‘MOT’ of your balance sheet, you can understand if you’re making enough money, if you have enough customers, or if anything needs to be tweaked to keep things running smoothly. Beyond this, carrying out regular reviews over the course of the year allows for you to estimate ahead and budget for any upcoming tax bills.

At this stage, you might be wondering if it’s worth hiring a professional accountant. This will depend on your business setup. For example, if you’re self-employed and running a home-based business with limited outgoings, like a writer or tutor, you might think it’s unnecessary. Whether you hire a professional or do it yourself, take advantage of accounting software for small businesses. The Countingup business current account comes with built-in accounting software so that you can keep onto of your business finances easily, even when you’re on the go. You can easily share data with your accountant to save time and money, or use it to manage the books yourself.

You need to think about where you’ll manage your business finances.

This will depend on your choices when registering a new business with HMRC. If you’ve formed a limited company, setting up a business account that’s separate from your personal account is a must.

If you’ve registered as a sole trader or partnership, you may not be obliged to open a separate business account, depending on the terms & conditions of your agreement with the account provider. It is, however, recommended that you do, as it’ll make monitoring your transactions much easier and help keep as clear an audit trail as possible.

You’ll find that many business expenses can be quite small, whether it’s lunch, some office supplies, or a bus ticket. If these are done through your personal account, they will be mixed in with all the other items you buy during the day. Deciphering them can then become more difficult and ultimately lead to inaccuracies in the tax calculations.

If you choose to open a business account, pick one that’s specially designed for small businesses. You can apply for a Countingup business current account for free and in a matter of minutes. The app will help you see how your business is doing day-to-day and keep track of your expenses.

With your business account in place, think about how you can plan ahead to make things easier in the short term and down the line.

Get a clear system in place for invoicing customers. Not only does it look professional, it also makes getting paid quicker and easier. Whenever you need to chase customers who haven’t paid up, you have a clear record to check it against. 

Invoices need to list the work done, agreed rate / fee, your account details the customer’s detail and the taxable date. You’ll also want to include a code or marker for filing purposes. You could, of course, use an app that does it all for you – one that creates professional invoices in an instant, lets you send them on the go, and helps you keep track of them.

Every business needs cash flowing regularly. Without it, you can’t get the stock and tools you need, or pay the bills at the end of the month. By having clear policies for invoicing and tracking expenses, you get a clear idea of what you can and can’t do each month without taking unnecessary risks.

Planning ahead will also avoid any shocks when it comes to filing and paying your tax return. Think about setting aside a percentage of your profit each month, depending on how much money you’re making. That way, you know the money is there in reserve. If you’re unsure of how much to set aside, use a business account that offers live tax estimates all year round, then you can put the funds away with confidence.

One of the most important aspects of small business accounting is bookkeeping. If done correctly, it puts your business in a great position. But what is it?

Bookkeeping is the process of recording all your business income and outgoings. Without it, accounting becomes very difficult, if not impossible.

A common method, used by many businesses, is double entry bookkeeping. This is where one transaction is accounted for in two separate accounts. For example, if you’re a software engineer and you buy a new computer screen, you enter the cost as coming out of your ‘cash’ account, but also as going into your ‘inventory’ account.

From day one, you need to be keeping meticulous records. Firstly, it’s a legal requirement. HMRC expects you to keep records of all income, expenses, VAT records (if registered for VAT), and PAYE records (if you have employees). You won’t need to submit them in your tax return, but you do need to keep these records for five years, or six if you’re a limited company.

If HMRC does ask to check them, and your figures turn out to be wrong and you don’t pay enough tax, you may have to pay interest and penalties.

It can sound a bit scary when put like that, but don’t worry. Small business bookkeeping is much less challenging than before. Now you can just take advantage of automated bookkeeping for small businesses. An app can remind you to record transactions as they happen, so they’re sorted.

Automation can save you time on certain processes, like reconciliation. This is where bookkeeping records are checked against bank statements to account for anything that doesn’t match. Now, the best business accounts feature real-time, accurate data that makes reconciliation unnecessary.

Your small business will have lots of regular costs. Don’t take any of these expenses for granted.

Some ‘allowable expenses’ can be deducted from your tax bill. These can include lots of common outgoings, including phone bills, train tickets and uniforms. It can even apply to business-related training and website costs.

You only pay tax on your profits. If you don’t track and account for these allowable expenses, no matter how small, it’s just more tax you didn’t need to pay.

Some expenses are pretty easy to overlook if you didn’t know about them. For example, if you work at least 25 hours a week from home, you can calculate allowable expenses for your home office, at a flat monthly rate. It ranges from £10 per month to £26, depending on the hours worked.

You can even claim back expenses like relevant annual licenses and subscriptions.

For limited company directors, additional expenses such as trivial benefits and staff entertainment costs can be considered too.

Get familiar with all the expenses you can claim back and don’t let any of them slip. 

If you’ve registered as a sole trader with HMRC, you file a self-assessment tax return each year. It’s the simplest way for small business tax to be filed.

If you’re self-employed, you don’t have to pay taxes on your earnings until the following tax year. So, any money earned in the 2020/21 tax year, which ends in April 2021, will be due by the end of January 2022.

When self-employed, your profits are your income. What you’re left with after accounting for your allowable expenses will determine your taxable position.

Everybody has a tax-free personal allowance of £12,570. After that, you need to pay Income Tax. Any earnings up to £50,270 are taxed at the ‘basic rate’, which is calculated at 20% for sole trader profits or salaries. Income above this is taxed at the ‘higher rate’ of 40%. If you make any earnings above £150,000, they will be charged at 45%. It is worth bearing in mind that dividends income attracts a different rate of tax to salaries or sole trader profits.

Keep in mind that if you earn more than £100,000, you’ll start to lose £1 of your personal allowance for every £2 earned above the £100,000 threshold.

You must also pay two types of National Insurance if you’re self-employed, depending on what profit you make. Class 2 applies if your profits are £6,515 or more per year, and Class 4 if your profits are £9,569 or more per year.

Keep in mind that no matter how you registered with HMRC, if your turnover (or estimated turnover) for the year exceeds £85,000 then you need to register for VAT. That means you’ll have to file VAT returns with HMRC, usually once every quarter. You must also sign up for the government’s ‘Making Tax Digital’ (MTD) initiative. From 1 April 2022, this will be a requirement for all VAT-registered businesses, regardless of their earnings.

Even if you aren’t registered for VAT, don’t ignore this. MTD is the government’s drive to make all businesses in the UK record their business transactions digitally. From April 2023, self-employed businesses with income above £10,000 will need to follow the rules for MTD and file self-assessment digitally.

By adopting accounting software now, not only will you be ready for MTD, but you’ll also make your tax needs much simpler.

Countingup is the business account with free, inbuilt accounting software that’s specially designed for small business owners. It will help you to keep your expenses in great shape and simplify your tax returns. Sign up today and get three months free.