Everything you need to know about accounting for small businesses

Running your own small business can be challenging and rewarding in equal measure. One thing’s for certain though – you’ll need to understand the basics of accounting if you want to succeed.

As any small business owner will tell you, the admin side of things can take up as many hours as you spend on the job itself. Managing accounts can get confusing, and you may not know what’s required of you, especially if you’re new to business ownership.

Don’t worry. We’ve compiled a basic guide to small business accounting to help you make sense of it all.

Where do I start?

First, consider what business structure you’ll be trading under.

If you’re reading this, you probably already know that the two common types of small business are sole trader and limited company. These two business types have different accounting requirements – although some aspects are the same.

It’s generally accepted that sole trader accounts are more straightforward than limited company accounts, as sole traders don’t need to worry about things like payroll, corporation tax and VAT.

Business set-up

Sole traders can use their personal bank accounts for business purposes. However, if you choose a limited company as your small business structure, you’ll need to set up a business bank account after registering your business with Companies House – this is a legal requirement.

Most high street banks will allow you to set up an account online.

Bookkeeping

The cornerstone of good accounting, bookkeeping involves logging every financial transaction that takes place within your business.

Bookkeeping is a legal requirement for limited companies, and it allows HMRC to clearly see the state of your business at any given time.

Bookkeeping tasks include:

• Recording money received for goods/ services
• Logging money spent by the business
• Paying bills
• Invoicing clients
• Preparing financial statements

Before the digital age, business owners painstakingly recorded each transaction by hand in a ledger book, and later, on an Excel spreadsheet.

These days, many business owners choose to use cloud-based accounting software, which allows for easier and more accurate bookkeeping via an automated system which records the time, date, amount and details of each transaction, as well as generating invoices and financial reports at the click of a button.

Despite this advancement in tech, bookkeeping is a notoriously time-consuming task and growing small businesses usually outsource it to an accountant.

Tax on business profits

Tax is an important part of small business accounting, and nobody should launch a business before finding out what their tax obligations will be.

Here’s a basic rundown.

Income tax and National Insurance (NI)

If you’re a sole trader, you’ll pay income tax on taxable profits made through your business, not counting anything declared as expenses. For the 2021/2022 financial year, the annual tax-free allowance for sole traders is £12,570.

If you make between £12,570 and £50,000 annually as a sole trader, you’ll be taxed at the basic rate of 20%. You’ll pay 40% income tax if your profit is between £50,000 – £150,000, and 45% if it’s higher than £150,000.

As a sole trader you’ll also need to pay NI contributions. Class I NI contributions are mandatory. Class II NI contributions are voluntary but are advisable in many cases as they help you qualify for benefits such as a state pension and statutory maternity pay.

As a sole trader, you’re allowed to deduct certain business expenses before you calculate your taxable profit. These include anything required for the running of your business – including vehicle running expenses, uniforms and office running costs (excluding buying business premises).

If you work from home, you’re still able to claim a portion of the costs involved, such as stationary. This is so long as they were purchased solely for use in a business context. Having said that, you can still claim a percentage of expenses that are used for both business and personal use – such as a portion of your phone bill, or heating costs for your home which includes a home office.

Self-employed people must complete an annual self-assessment for the previous financial year, which is usually done online on the HMRC website.

Corporation Tax

Unlike sole traders, limited companies aren’t liable to pay income tax on profits. This is because the money made by a limited company is attributed to the company, not an individual. For the same reason, limited companies aren’t liable to pay NI either.

However, limited companies must pay corporation tax on profits, with any allowable expenses deducted. These expenses include costs involved in running the company, including travel, mileage, training and staff salaries – but not business assets like vehicles and equipment.

For the year 2021/22, the rate of corporation tax is 19%. Unlike with sole trader profits, there is no tax-free allowance for limited companies. The 19% tax rate applies to any profits which remain after business expenses have been deducted.

Further, unlike with sole traders, there is no sliding scale of tax relative to the amount you earn. Currently, all limited companies, large and small, must pay 19% corporation tax.

If your business qualifies, there are certain tax reliefs which could bring down your corporation tax bill. These include tax breaks for creative enterprises as well as science and tech firms. Checking your entitlement with a tax professional could see your business make serious tax savings.

Payroll

If you’re a registered limited company and you employ any staff, you’ll need to run a weekly or monthly payroll.

Payroll refers to the overall process of paying employee salaries, and all that involves. This includes:

• holding an up-to-date list of company employees and their details
• calculating the amount an employee is to be paid
• paying salaries each week or month
• deducting tax, National Insurance (NI), student loan repayments and pension scheme contributions and sending to HMRC
• paying sick pay, maternity pay and holiday pay
• deducting any salary sacrifice payments
• ensuring staff receive any tips or bonuses they’re due

So long as your staff are paid at least the National Minimum Wage (for under 25s) and the National Living Wage (for over 25s), you can set your own salary amounts. The director of a limited company can choose to pay themselves a nominal salary (for example, £12,507 so as not to exceed the tax-free threshold) and pay themselves the rest in dividends.

Before taking on any salaried employees earning above the Lower Earnings Limit of £120 per week, you’ll need to register for Pay As You Earn (PAYE) with HMRC. This is the system by which HMRC collects tax, NI, student loan repayments and more from a person’s salary and pays it directly to the government. It’s also referred to as being ‘taxed at source’.

You can register for PAYE on the HMRC website. You’ll receive a PAYE reference number which you’ll need when submitting payroll information to HMRC data each month.

To run payroll yourself, you’ll need to use HMRC-approved payroll software, into which you’ll input the amounts your employees have earned each month. The software will then calculate the gross amount the employee is due to be paid along with the deductions for each employee. It’s then up to you to pay both the employee and HMRC in a timely manner. It’s important to remember that HMRC must be paid no later than 22nd of the month following the employee’s payday.

Despite the automated software, payroll can be a time-consuming task for small business owners – especially if they’re keen to scale up their business – so it’s commonly outsourced.

Reporting to HMRC

Now you’re a business owner, you’ll need to add some important dates to your calendar. These are the HMRC reporting deadlines, which will now serve as the framework for your future business accounting timeline.

This is especially true for directors of limited companies, who have more detailed reporting requirements than sole traders.

Reporting requirements for limited companies include:

First accounts

This is the initial set of accounts which are due 21 months from the date your limited company was registered with Companies House.

Year-end accounts

You must submit annual accounts – to include a balance sheet, profit and loss account, list of assets and a director’s report – to HMRC, Companies House, shareholders and various other stakeholders. These are due at the end of every financial year.

Corporation tax

You can work out how much Corporation Tax you’re liable for by completing a company tax return (more on those below). Corporation tax payment deadlines aren’t set in stone – they depend on your company’s accounting period.

Corporation tax must be declared and paid to HMRC nine months after the business’s accounting period for the previous financial year ends.

Company tax return

Confusingly, your company tax return isn’t due until after you’ve paid your Corporation Tax, but you’ll probably need to complete your company tax return before paying your Corporation Tax to find out how much your business owes.

Your company tax return must include details of profits and losses for Corporation Tax, as well as the final amount you owe.

Your company tax return must be submitted three months after you pay your Corporation Tax, so 12 months after your company’s accounting period ends.

Reporting requirements for sole traders include:

Self-Assessment tax returns

All sole traders must fill out an annual Self-Assessment tax return, to be submitted no later than 31 January for the previous financial year. You should also pay any tax you owe by this deadline.

There is another deadline of 31 July for those who make ‘payments on account’, meaning advance payments on your tax bill.

In most cases, directors of limited companies must file an annual Self-Assessment tax return declaring details of their income and personal allowances. The exception to this is if all income is taxed at source via PAYE.

Filing your Self-Assessment tax return late usually results in a late penalty of £100, and if it’s over three months late you’ll be charged £10 for every day it’s overdue.

VAT

Value Added Tax – or VAT – is the tax you pay on goods and services in the UK.

Any business making over £85,000 must register for VAT on the gov.uk website.

Not everything is eligible for VAT – children’s clothes and newspapers are exempt for instance – but most things bought and sold in the UK carry this extra charge. The VAT rate is currently 20% for most items. Other VAT rates apply for other things, such as 5% VAT on restaurant food.

As a small business owner, you must apply this charge to the cost of your goods and services. If you produce invoices, for instance as a tradesperson, the VAT charge must be listed separately alongside what you’ve charged for the service. You must also display your VAT number. For most other items, such as electronics and clothes, the VAT is added to the gross price.

After your business becomes VAT registered, you must submit a VAT return online four times per year. To do this, you must keep a thorough record of all VAT you’ve charged your customers during the quarter and declare it to HMRC, quoting your business’s personal VAT number.

Sometimes, it can be beneficial to register for VAT even if your turnover is below the £85,000 threshold – check with an accountant whether this could be the case for your business.

You must now handle VAT in accordance with Making Tax Digital (MTD), which requires you to submit your returns online using HMRC-approved software. The go-live date for MTD is April 2022.

Can I get help with small business accounting?

Yes – and most small business owners do.

The truth is, we haven’t even scratched the surface of what’s involved in managing the accounts for a small business.

If you’re concentrating on growing your small business, it’s easy to miss important reporting deadlines, miscalculate figures and end up in a pickle with your bookkeeping.

The most efficient way to ensure your accounting is accurate, on time and that you’re making the most of tax reliefs due is to work with a good accountant. If you are interested in our accounting services for small businesses, please get in touch today.