Managing your finances as a small business owner can be daunting, especially when it comes to making that first self-assessment tax return.
Aside from the basic where, when and how of submitting your return, there are likely to be questions around what can and can’t be claimed, how records should be kept, and what will happen if HMRC has questions about your accounts.
Businesses need to keep records of all sales and income, their expenses, VAT records if they are registered for VAT, PAYE records if they employ staff, personal income records, and any grants they may have claimed.
This information is used as the basis for tax returns, when profit or loss figures need to be calculated and submitted to HMRC. It is worth noting that the amount of tax owed is calculated on an annual basis rather than the pay as you earn method you may have been used to as an employee.
Also, it is important to note that the tax year runs from April 5 to April 6, and HMRC works out the tax which businesses owe based on that year. All records should be kept for five years.
Managing your finances as a small business starts with some very basic requirements, including:
One important question you should consider as early as possible is whether you will be using an accountant to handle these questions, as well as if you intend to use accounting software such as Quickbooks, Sage or Xero.
Small businesses should also consider which type of accounting method they will use. There are two types to choose from:
It is possible to use a hybrid version of these two methods by doing day to day accounting on a cash basis, but planning for major financial decisions using accrual accounting.
If you are operating as a limited company, it is a legal requirement to use a business bank account. This is not the case for sole traders, where you are legally seen as your business and so do not need to have a separate bank account.
Even if you are not required to have a business bank account, it is good practice to separate your business income and expenses from your personal finances.
Creating a clear boundary between personal and business transactions can make it easier to complete your tax return and monitor cash flow. It is also useful should your accounts ever be audited.
It is essential to record every business transaction you make, whether that be grabbing a morning coffee while on the way to a meeting, paying your rent, or buying software and equipment.
Keeping and filing receipts from these activities is also important to prove the expenses you are claiming are valid.
The same is true for any income, with an invoicing system a vital part of any small businesses’ armoury.
HMRC has the power to review your records in order to check you are paying the right amount of tax, so it is vital that you can prove everything you are saying on your tax returns.
Developing a system for capturing receipts and sending out invoices, as well as categorising expenses according to the tax you can claim, is not only essential when dealing with the tax man but can provide valuable insights into spending patterns and cash flow.
If your small business is not claiming allowable expenses, then you will end up paying too much tax.
This can be the result of not only poor record keeping, but also not knowing which expenses you can and can’t claim.
HMRC’s general rule when it comes to determining what does and doesn’t qualify as an allowable business expense is simple: is the purchase made wholly and exclusively for business purposes?
This means you can claim items such as uniforms, laptops, furniture and relevant equipment.
What you can and can’t claim also varies depending on whether you are operating as a sole trader or a limited company.
Sole traders are able to claim items including:
Not everything can be claimed though, with notable exceptions including fines for parking tickets.
If your business is a limited company, you may be able to claim for activities such as one-off advertising fees, business trips and travel, entertainment, eye tests and formation costs, but items such as childcare costs can’t be claimed.
Whether you are a sole trader or running a limited company, it is important to check whether each expense is eligible or not.
Small business finances can easily become an afterthought as your time is filled with searching for new business and fulfilling commitments to clients.
But managing your cash flow can have a hugely positive effect on any business, easing potential financial headaches and propelling you towards growth.
Cash flow management includes tasks such as:
Accounting software can help ease the headache of managing your finances. Many packages allow small business owners to automate financial admin and data entry, generating financial reports and providing life information that summarises your income and outgoings.
Specialist accountancy tools can make managing your finances far easier, helping reduce the amount of time it takes to manage a paper-based system and reducing the risk of mistakes.
In the future, the government’s Making Tax Digital agenda will mean this software is not simply desirable, but a requirement needed to report your income to HMRC.
Finally, small businesses should consider taking out Legal Protection Insurance. Although this is tangential to managing your finances, it is vital to ensure you are protected against any HMRC tax queries.
Legal Protection Insurance covers the cost of defending or pursuing legal disputes, providing expert representation and protecting self-employed individuals against unexpected legal costs and tax investigations.
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