The complete guide to small business accounting
Understanding the basics of small business accounting is a key part of building and managing a successful business.
Because it arms you with vital information that will help you to make smarter decisions, both large and small, about your business operations, strategy and growth plan.
In this guide, we’ll share everything you need to know in order to organise your small business accounts. We’ll dive into the basics of accounting, the purpose and importance of those tasks and how to use this knowledge to your advantage.
- 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
- Expert insights
- Wrapping up
What is small business accounting?
Small business accounting is the process of identifying, recording, measuring and interpreting financial information.
Keeping on top of your financial records, expenses and revenue allows you to monitor your profit and loss. It also helps you manage the value of your assets, liabilities and equity.
While this makes managing your cash flow easier, you also have a legal duty to ensure your accounts reflect this information accurately.
But beyond the basics of what small business accounting is, it’s crucial to understand why it matters.
Put simply, the purpose of accounting, like any other measurable data stream, is to help you plan, evaluate and optimise your business on the whole.
In general, small business accounting can help you with:
Budgeting and planning
Setting and maintaining a business budget helps you to align your spending with your business goals, forecast your earnings and hold yourself accountable.
For example, a budget helps you to determine which resources are essential or optional so that you can avoid spending money on unnecessary or ‘nice to have’ assets when your cash flow doesn’t support such behaviour.
Additionally, a well-thought out budget can help you acquire funding or raise venture capital as it gives potential investors a clear picture of your spending needs and your forecasted spending objectives.
Top Tip: To learn more about how a business budget can help you reach your business goals, read our 8-step guide to creating an effective business budget 💡
Accounting plays a key role in most of the high-level decisions you’ll make as a business owner.
For example, maintaining a healthy cash flow is one of the key markers as to whether or not a business will survive long-term. If you do happen to run into cash flow problems, financial reports can help you identify potential areas where you can make adjustments to bring more cash in.
This may mean changing the price of your products to increase sales, or finding a new supplier with lower costs so that you can increase your profit margins.
Either way, having organised and up to date financial information allows you to assess a problem (or an opportunity) and make faster and smarter decisions as a result.
Analysing your key performance indicators (KPIs) helps you to understand if you’re achieving your financial goals. Without these reports, you won’t have a meaningful way to determine if you need to pivot on your strategy or optimise your goals in any way.
For example, if you set a revenue goal for £100,000 in your first year of business and you achieve that, that would be considered a win. But, at the same time if you ended up spending 3x more than you planned, you may actually have lost more money that you brought in.
Financial reports allow you to evaluate not only how your business is performing, but if your goals and objectives are in line with your short and long-term growth strategy.
You don’t need to be a maths expert to get started with small business accounting. Let’s run through seven basic principles to help you get set up the right way.
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.
Ideally, your business account will have multiple features that makes your finance admin easy to manage.
For example, when you open a free business bank account through Tide, we automatically tag and categorise your income and spending so that it’s easy to see exactly where your money is going. We also make it easy for you to create, send, pay and track invoices directly from our app, helping you to stay on top of your invoices from anywhere at any time. Plus, our accounting integrations save you tons of time and will make your accountant’s life much easier (if and when you hire one).
Top Tip: Not sure which software to choose for your small business? We’ve put together a list of small business software, from accounting services and bookkeeping, to marketing and customer relationships, to help you get a lay of the land. To get started, read our guide to the 26 best software and tools for small businesses 🔍
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.
Here are just a few of the main reasons why accountants can make your life easier:
- Accurate records allow you to track cash flow and forecasting, which helps you to evaluate business performance and make smarter business decisions (as mentioned above).
- Having your books in order will make getting a loan easier (especially if you’re cash flow positive) and make tax season a much more enjoyable experience.
- 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.
Top Tip: Accounting and bookkeeping are similar in spirit but vary significantly when it comes to roles and responsibilities. To learn more about why each role is important and how to decide if you need to hire one, or both, of these key positions for your business, read our guide to the difference between an accountant and a bookkeeper 📌.
“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).
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.
These costs range from employee salaries to materials for making your products to marketing expenses and anything else that you need to spend money on to run your business.
Business expenses can be deducted from your company’s income before it is subject to taxation. This tax relief can only be claimed if you submit an accurate record of every single business expense for up to six years—yet another reason why accounting not only saves you headaches, but money (we’ll dive into the specifics of what you can claim in a moment).
Why is it important to track your expenses?
Tracking your expenses may sound like hard work, but as mentioned above, advanced business accounts (as well as most online accounting software) will track your outgoings for you.
It’s important to track your expenses because it gives you a better understanding of how you’re spending your money and could help you claim some of it back.
In turn, this helps you to control your outgoings and identify what you’re spending your money on, ultimately allowing you to save money and free up some capital to invest in other areas of your business (such as marketing).
Top Tip: There are three main types of expenses: operating expenses, non-operating expenses and capital expenses. To learn more about what each category means and why it’s important to differentiate them, read our guide to what expenses are and how small businesses can manage them 🌟
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:
- Labour. 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, if you host a holiday party for your staff, you can claim £150 (including VAT) per guest. 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.
Top Tip: To learn more about the expenses that you are entitled to claim (as well as how exactly to make a claim), read our guide to the allowable expenses that limited companies can claim 📣
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.
Many small business owners just starting out use expense spreadsheets to track their expenses. They’re free, relatively easy to maintain and better than a handwritten record. If you fall into that category, you can download our free expense spreadsheet to get started.
As you grow, we recommend automating as much as possible using online software.
What about tracking employee expenses?
If you have employees, efficiently tracking their expenses is a key part of sticking to your budget, monitoring your employees’ spending patterns and reimbursing them for any out of pocket expenses.
Step one is to create a clear and transparent company expense policy to ensure everybody is on the same page.
Step two is to manage employee expenses in order to ensure the process is running smoothly.
And step three is to adopt modern expenses solutions to streamline your operations. Tide’s company expense cards make the entire employee expenses process easier for everybody involved.
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 £150,000 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).
Top Tip: To learn more about the different types of accounting methods, as well as the three main financial statements that every startup accounting system is based on, read our complete guide to accounting for startups 🚀
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, and the better it is for your cash flow and peace of mind.
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.
Top Tip: Be careful not to confuse an invoice with a receipt or a purchase order, as these are all documents that are similar but designed for specific use cases. Also, be sure to understand whether or not you need to include VAT on an invoice and if so, how exactly to do that. To learn more, read these three helpful guides: The difference between an invoice and a receipt; The difference between purchase orders and invoices; What to include on your VAT invoice 🚨
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.
Or, you can remove all of your worry and take advantage of invoice chasing and auto-matching with Tide. Instead of the time consuming task of manually following up with clients or customers, simply schedule auto-reminders and then sit back and wait to be automatically notified when it gets paid.
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. This is 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.
5. Set up a bookkeeping system
As mentioned above, 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.
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.
If you want to make your bookkeeping as easy as possible, an accounting platform like Xero, QuickBooks, Sage, or KashFlow will automate various bookkeeping tasks for you.
6. Calculate your business tax
Many small business owners feel 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
- Work out the allowances you can deduct from your taxable income or your final tax bill
- Work out at what rate your income is taxed
- Consider whether you can deduct anything from your tax bill
If you are registered as a Sole Trader, you must pay Income Tax through HMRC’s Self Assessment tax return.
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.
The Making Tax Digital program came into effect in 2019 with the intention of simplifying the tax return process. Learn what it means, why it is happening and who it impacts by reading our guide to Making Tax Digital.
Top Tip: To learn more about the different types of small business tax and which ones apply to your company, read our simple guide to small business tax ⚡️
7. Check if you need to register for VAT
Regardless of your business structure, you must register for value added tax (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.
Top Tip: To learn more about what VAT is, how much it is, whether or not you need to register for it and how to charge it, read our complete guide to everything you need to know about VAT ✅
💡 Expert insights
Insights author: Caroline Plumb, CEO and Founder, Fluidly
How can business owners make their small business accounting easier to manage?
Cloud accounting tools like Xero, QuickBooks and Sage are now the norm for most businesses, especially after the government’s Making Tax Digital scheme. But with so much choice, deciding which accounting package to go for can be a challenge.
Fortunately, you can try before you buy – so set up some trial accounts to test which tools are easiest to use and fit best with your requirements. After that, you’ll be in a better position to make a call.
It’s also worth thinking about other apps and add-ons you might need, which can connect to your accounting software and save you even more time.
If you have an accountant, they should be able to help too. These days accountants are a lot more tech-savvy – yes, they can look after your tax returns, your bookkeeping and your company’s legal structure, but they can also provide advice around areas like software, funding and cash flow.
Looking after your cash flow is critical, during normal times and exceptional ones. But in between your daily responsibilities, your cash situation can go overlooked, especially when you’re under pressure.
Cash flow is all about the money flowing in and out of your business. If the cash coming in is greater than the cash going out, then your business is probably in good financial health. But maintaining positive cash flow isn’t easy.
Ensuring the money coming in is reliable and consistent is a good place to start. During the pandemic, supermarket brands like Morrisons have helped at-risk businesses by choosing to pay their smaller suppliers immediately. Your customers may be open to a similar arrangement, so see if there’s room to negotiate more favourable payment terms.
Either way, Direct Debit tools like GoCardless help you get paid regularly, while invoice chasing tools allow you to easily recover money locked in unpaid invoices. It’s also important to pay close attention to the smaller costs flowing out of your business, so make sure you regularly review non-essential expenses.
Your landlord and the tax man may be more amenable than you think too, particularly right now. Look into renegotiating your lease and if you can’t pay your tax bill on time, check out HMRC’s updated ‘Time to Pay’ scheme.
Ultimately, cash flow planning is the best way to stay on top of the money moving through your business. But creating a cash flow forecast the traditional way can take hours. Your business’ finances are constantly changing too, so even the most complicated spreadsheets are too static to do it justice.
An automated tool which learns from your data to generate a forecast in minutes, makes things a lot easier. What’s more, it’s always up to date, easily syncs with your other accounting software and can help you access finance options too.
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