Managing money becomes even more important when you become your own boss. From expenses to tax, spending to saving, there is lot to think about. But with careful planning and budgeting, sole traders can avoid any financial pitfalls.
Budgeting is vital if you want to manage your financial wellbeing. While it may be tempting to spend all your time chasing new clients or meeting deadlines, setting a workable budget is equally, if not more, important.
Generating income may seem like your number one priority, but if you are not tracking your outgoings, then there is a risk you won’t have the complete financial picture.
As a sole trader, you are your business. Any financial liability will fall directly on your shoulders, meaning you could even be made bankrupt or lose personal assets if things go wrong.
Creating a budget begins with breaking down your earnings and spending. How much did you earn in previous months and what are your regular outgoings?
In the world of a sole trader, this is sometimes easier said than done.
Contracts and income may not be consistent, meaning there will likely be variations month by month – potentially extreme ones.
In this case, careful analysis of your figures will indicate which months you traditionally earn more or less, which can help with your planning. Once you know which months you earn less in, you can put money aside in advance to address that shortfall.
New sole traders will need to estimate their earnings over the next year. When doing so, it is best practice to err on the side of caution. If that big ‘maybe’ contract does come through, then it will be a bonus.
When calculating expenditure, a banking app can be really useful. Many apps nowadays will break down your spending into categories.
By simply deducting each month’s outgoings from your incomings, you will be able to see your cash flow across a year.
This budget may not be 100% accurate and will have moving parts to it, meaning it will need to be monitored and updated regularly.
When budgeting, sole traders and freelancers should also bear in mind that many of the benefits we get as regular employees no longer apply. For example, people who are self-employed are responsible for their own pension, while they will no longer be getting paid if they take a day’s holiday.
It is also important to ‘expect the unexpected’. Sometimes a project and payment can take longer than expected. Building in margins can protect you against those moments and ensure all your bills are paid on time.
It can be easy for the fine line between personal and business finances to become blurred, but this can cause problems down the line - particularly when it comes to completing your tax return.
Even though as a sole trader you are not legally bound – as limited companies are – to have a business bank account, it is a sensible step to set one up.
Conducting both personal and business budgeting gives you a complete picture and can help you avoid any unwelcome surprises.
Personal accounts should be used for bills and living expenses, from energy and broadband to council tax. While some of these items may be tax deductible against your business income, it is sensible to ensure such core outgoings remain non-negotiable and are paid each month. Any tax calculations involving them can be done later.
A business account should receive all your working income and be used to pay business expenses. Using your account in this way will make it easier to track incomings and outgoings when it comes to compiling your tax return.
Talking of which…
Self-assessment is the bane of many a sole trader and freelancers’ life, but it is a chore that can be made far more palatable with careful planning.
The first thing to remember is that everyone has a personal tax allowance, meaning you can earn £12, 570 a year tax free.
Keeping a thorough record of allowable business expenses, coupled with developing a strong knowledge of exactly what you are entitled to, will also reduce your level of taxable profit.
Taking proper account of deductible expenses like professional courses, business-related travel, or home office costs can significantly reduce your taxable income.
You’ll also need to calculate the percentage of tax that you will be liable to pay, depending on your income.
With all this data, you can put together an accurate idea of how much tax you will be charged. You can then start to put aside a percentage of income to account for that tax.
Putting money aside in this way is the number one rule for sole traders. Tax is payable on January 31 and July 31 every year, and if any payments are missed there will be a penalty and interest to pay.
Tax planning is as important for businesses which are making a loss as it is for profitable ones. If your business is loss-making, offsetting those loses against other taxable income can reduce your overall tax burden and provide a cash flow relief in challenging times.
Sole traders, freelancers and contractors can benefit hugely from hiring an accountant to help with budgeting. Accounting professionals can help with the creation and maintenance of a budget, offering advice and identifying areas for cost reduction or increased income.
A good accountant can also help with tax regulations and help you optimise your tax strategy to make sure you are claiming the correct items and avoiding missing any payments.
There are also several tools available to help with budgeting.
Business bank apps will often be able to break down your spending into different categories, allowing you to analyse what you are paying out for and, if necessary, need to cut back on.
Specialised budgeting tools and apps allow people to see all their bank accounts in one place, will analyse your spending habits, and can set budget goals.
Meanwhile, accounting software can streamline tracking and budget management while keeping track of receipts and invoices.
Taking advantage of some of these tools can take the strain off when budgeting, leaving you with more time to tackle the rest of your ‘To Do’ list.
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