The complete guide to small business accounting
Getting to grips with small business accounting may sound daunting. But it is critical to understand how your accounts work in order to build and manage a successful business.
In this guide, we’ll share everything you need to know to organise your small business accounts. You’ll learn the basics of accounting, along with some further reading to help you dig deeper into the details.
- What is small business accounting?
- Step 1: Open a separate business current account
- Step 2: Work with an accountant
- Step 3: Track your expenses
- Step 4: Set up an invoicing system
- Step 5: Set up a bookkeeping system
- Step 6: Calculate your business tax
- Step 7: Check if you need to register for VAT
What is small business accounting?
Small business accounting is the process of identifying, recording, measuring and interpreting financial information.
While this makes managing your cash flow easier, you also have a legal duty to ensure your accounts reflect this information accurately.
Small business accounting basics:
Knowing how to manage everything from invoicing to expenses can seem overwhelming. But you don’t need to be a maths expert to get started. Let’s run through the basic principles to help you get a good understanding of how small business accounting works.
1. Open a separate business current account
If you’re registered as a limited company, you’re legally required to have a separate account for your business finances. If you’re a sole trader, whilst you’re not legally required, it is recommended to keep these separate to save you some headaches. Check the T&Cs of your personal bank account as some specify that your account may be closed if it is used significantly for business purposes.
When Kate Holmes founded her home furnishings brand Kitty Holmes, her entrepreneurial sister had one piece of advice for her:
‘Just make sure your finances are separate.’
Getting your business account in order requires two simple steps:
- Choose a business account: When choosing an account, consider factors such as transaction fees, withdrawal fees, introductory offers, customer support and admin features.
- Set-up a savings account: This will help you organise your funds and plan for taxes. If you’re self-employed, set up a separate savings account to put away a percentage of each payment you receive for taxes.
Not sure which accounting software to choose? Here’s a list of small business software to help you decide.
2. Why you should work with an accountant
Entrepreneurs wear many hats and, as a result, company accounts can often be left unattended. This can lead to problems down the road if you make any accounting mistakes.
- Accurate records allow you to track cash flow and forecasting.
- Having your books in order will make getting a loan easier (especially if you’re cash flow positive).
- Less time spent on bookkeeping means more time working on building and growing your business.
From forecasting to tax audits, loan applications to VAT registration, an accountant can make life easier for you. When it comes to choosing an accountant that is right for your business, it is wise to identify your business needs, look into the accountant’s fee structure, and obtain an engagement letter. Most accountants charge flat monthly rates for their bookkeeping and accountancy services.
“I really like the integration of Tide and Xero. It’s so seamless. I can just send it all off to my accountant. For someone like me without an accounting background, it’s very easy.“
Kate Holmes, founder of Kitty Holmes
Meet Harvir, the founder of Doyenne, a new flexible-working platform for women:
Harvir says she uses Tide’s banking app features alongside using an accountant:
“I don’t have the most user-friendly accounting software that comes free through my accountant,” she says. “So I much prefer looking at Tide.”
Harvir Sangha, founder of Doyenne
Tide’s account reader also gives Harvir’s accountant ongoing read-only access to her transactions, allowing them to manage statements and view her transactions.
3. Track your expenses
You should always keep on top of your expenses and outgoings. By neglecting your expenses, you may come across cash flow issues that can be avoided (especially in the early days of running your business). Let’s dive into what expenses are and how you can track them.
What are expenses?
An expense is an amount spent or cost incurred in your efforts to generate revenue. In other words, it is your cost of doing business.
Business expenses can be subtracted from a company’s income before it is subject to taxation. This means you don’t have to pay more taxes than you should.
Why is it important to track your expenses?
Tracking your expenses may sound like hard work, but it doesn’t have to be the case. Most accounting software will track your outgoings for you. And tracking expenses gives you a better understanding of how you’re spending your money and could help you claim some of it back.
You’ll be able to control your outgoings, find out what you’re spending your money on and how much you’re spending. This not only allows you to save money, but free up some capital to invest in other areas of your business (such as marketing). Read more about putting together a go-to-market strategy in our dedicated guide.
What can you claim as a business expense?
This area can often cause confusion. To clarify, here are some examples of what can be claimed as an expense when doing your small business accounting:
- Labor: Full-time employees, independent contractors, consultants and freelancers all fall within this category.
- Rent, utilities, phone and supplies: Rent, bills and other office expenses can be deductible as a business expense. If you work from home, a percentage of your bills and rent can be claimed against the business.
- Business travel: If the purpose of a trip is for business (e.g. meeting suppliers or clients), then you can claim it as an expense.
- Transportation: Record when, where and why you used any vehicle for business and keep any rental receipts.
- Benefits, education and training: If you offer your employees dental insurance or the opportunity to further their education or learn new skills, these can be deductible business expenses for you and/or your employees.
- Entertainment: You’re allowed to claim £150 a year per employee for entertainment (which includes yourself). For example, your Christmas party, if open to all employees that costs under £150 per employee, would count as an expensable entertainment event. Note that you cannot claim any entertainment expenses if you’re a sole trader.
- Food: Business lunches with clients are deductible at 50%, as are employee lunches taken whilst travelling for business purposes.
What can’t you claim as a business expense?
Here is a list of outgoings or costs that are NOT deductible as business expenses:
- Fines and penalties: The most common fines for small business owners are for failure to file by the due date and late payment which can’t be claimed as an expense.
- Political contributions: You can’t deduct contributions your business made to a political party or candidate.
- Hobby related expenses: If you belong to a country club, social club or fitness facility, your dues are not a deductible business expense.
How to keep track of your expenses?
Set up a system for organising your receipts and records as soon as you start your business. While many business owners still use spreadsheets, we recommend automating as much as possible using online software.
As well as helping you to categorise transactions, Tide allows you to add comments and photos to transactions (for example, a photo of a receipt). This will help you easily keep track of your expenses.
How to organise your expenses?
The next step is to determine which small business accounting method you’ll be adopting to organise your expenses. There are two methods:
- Cash method: Revenues and expenses are recognised at the time they are actually received or paid.
- Accrual method: Revenues and expenses are recognised when the transaction occurs (even if the cash isn’t in or out of the bank yet) and requires tracking receivables and payables.
Cash basis accounting is generally more suitable for small businesses with a turnover of £83,000 or less and is an optimal way to work out your income and expenses for your Self Assessment tax return (if you’re a sole trader or partner).
Pro Tip: If your business is home-based, there is a great chance you’ll be able to deduct certain home expenses used for your business too (think Wifi, phone bill, or transportation).
4. Set up an invoicing system
A well-oiled invoicing system is the heart of your small business accounting. An invoice is prepared based on products or services sold and needs to be fast and accurate. The sooner your invoice is sent, the sooner you’ll get paid, and the better it is for your accounting.
What is an invoice?
An invoice is a document sent by the provider of a service or product to the purchaser. The invoice works as a verification of the agreement between buyer and seller, establishing an obligation to pay on the part of the purchaser.
Here are five tips to make invoicing and getting paid a breeze:
1. Automate your invoicing
With online invoicing, you can easily send invoices directly to customers without any postage costs. Not only that, but it gives clients an easy way to pay online.
You can also set up recurring payments, which is convenient if you’re working on a long-term project or you run a subscription-based business. Here is what invoice sending looks like within the Tide app:
2. What to include on an invoice
As a minimum, your invoices should include:
- A unique identification number
- The date of the invoice
- The date the goods or service were provided (supply date)
- The client’s name (or business name)
- The client’s email address
- The client’s address
- Your name (or business name)
- Your business address
- Your contact details
- A clear description or an itemised list of product/services
- Costs for each item
- VAT amount if applicable
- Total cost/amount owed
- Your preferred payment method
You can include your BACS or account and sort details at the bottom of the invoice. We’ll dive into the different payment terms available shortly.
3. Establish payment terms
Your payment terms and policies determine when and how you’ll be paid. If you’re a freelancer, you should discuss this with your clients and set expectations as you establish a relationship. This way, they won’t be surprised when they receive an unexpected bill.
4. Prepare for late payments
At some point, you’re likely to come across a client who will fail to pay you on time. This can be a huge issue for a small business, but whatever happens; stay calm.
You can extend their deadline or suggest a payment plan to make it easier on their own cash flow. You could also implement late penalty fees when the invoice goes past the due date to prevent it from happening again.
5. Example payment terms
Not sure what your payment options are? Below are four of the most common payment terms. Choose one that works best for your business model:
- DOR or Due On Receipt: ensures your invoices are paid on time since the money can come to your account instantly.
- PIA or Payment In Advance: a payment that’s made ahead of schedule for your products and services.
- EOM or End Of Month: the payer must issue payment within a certain number of days following the end of the month.
- COD or Cash On Delivery: this means goods will be paid for on delivery.
Platforms like Stripe also allow for automated billing, which is perfect if your business operates on a subscription model.
5. Set up a bookkeeping system
When setting up your small business accounts, you may hear the terms “bookkeeping” and “accounting” used interchangeably.
But there is a big difference between the two. “Bookkeeping” is the process of recording financial transactions, whereas “accounting” is the process of categorising, analysing and summarising these transactions. You can find out more over here on the difference between a bookkeeper and an accountant.
How to track your company records
If you’re not ready to invest in an accounting software, you can use free alternatives to track your business expenses, as well as goods and services sold on a monthly basis.
For example, you can use Google Sheets to quickly put together a simple bookkeeping system. Check out these free Excel bookkeeping templates from Business Accounting Basics to get started.
If you want to make your bookkeeping as easy as possible, an accounting platform like Xero will automate various bookkeeping tasks for you.
6. Calculate your business tax
Over 600,000 British small businesses admit to missing their tax return deadlines, with a third feeling overwhelmed by the burden and complexities of small business accounting.
Filing your tax return can be a complicated and scary prospect. But as long as you do it on time you’ll be fine. Even if you do miss a deadline, it can be easy to fix by letting HMRC know of your circumstances.
Depending on the nature of your business, there may be different types of tax you’ll need to pay.
How to calculate your tax if you’re a Sole Trader
- Work out whether your income is taxable or not: Some income is taxable and some is tax free.
- Work out the allowances you can deduct from your taxable income or your final tax bill: There are several different tax allowances to which you might be entitled. For most people, the personal allowance for the tax year beginning 25 April 2019 and ending on 24 April 2020 is £12,500.
- Work out at what rate your income is taxed: If you qualify, some of your savings income might be taxed at 0% and that means no tax will be due on it. Below is a table showing the tax rate per income band.
- Consider whether you can deduct anything from your tax bill: The most common deduction is UK tax you have already paid. You may also be able to deduct foreign taxes paid on income which is also taxable in the UK, as part of a foreign tax credit claim.
If you are registered as a Sole Trader, you must pay Income Tax through HMRC’s Self Assessment tax return:
Taxable income and tax rates for Sole Traders
|Band||Taxable income||Tax rate|
|Personal allowance||up to £12,500||0%|
|Basic rate||£12,501 to £50,000||20%|
|Higher rate||£50,001 to £150,000||40%|
|Additional rate||over £150,000||45%|
How to calculate your tax if your company is registered as a Limited Company
If your company is registered as a Limited Company you must pay Corporation Tax through HMRC’s Company Tax Return: Corporation Tax is like Income Tax for companies, but the difference is that companies don’t have a personal allowance. This means that as soon as your business starts making a profit, you need to start paying Corporation Tax at the Corporation Tax rate (unless you’ve previously made a loss).
Remember, a good accountant will help you calculate all this for you. However, as a business owner, it is useful to know how everything works.
Pro Tip: “Making Tax Digital” came into effect in 2019. Learn what it means, why it is happening and who it impacts here: What is Making Tax Digital?
7. Check if you need to register for VAT
Regardless of your business structure, you must register for VAT if your annual turnover (sales) is £85,000 or more. Registration remains optional if your turnover is below that threshold.
That means you’ll charge your customers at the 20% rate of VAT, which means adding 20% to your invoices and keeping this amount aside from what your customers pay you.
You’ll then be able to reclaim any VAT you have paid on business-related purchases and expenses. You must also pay the net amount of the two over to HMRC. VAT returns and payments are due on a quarterly basis.
As you can see, managing your small business accounts isn’t as complicated as you might think. The more organised you are, the easier it is to keep on top of your books.
Of course, getting help from a chartered accountant can make life much easier. Ask some fellow entrepreneurs who they recommend and be sure to find someone who understands and cares about your business.
Photo by Brooke Cagle, published on Unsplash