By Timothy Adler on Small Business UK - Advice and Ideas for UK Small Businesses and SMEs
If you’re already one of the 3.1 million sole traders in the UK, you’ll know there’s a pretty overwhelming you need to learn and do as a business owner. When you work for yourself, you’re often juggling multiple hats which is why bookkeeping is often a task that many a sole trader would rather forget about.
Whether you’re an established sole trader or thinking about working for yourself and becoming self-employed, swatting up and finding out more about bookkeeping for sole traders, getting to know the terminology and getting a good bookkeeping process in place, is one of the most beneficial things you can do to help your business.
‘Don’t just do bookkeeping because you must – do it because it will help you and your business’
What is the difference between sole traders and self-employed?
These terms are often used interchangeably to describe individuals who work for themselves but there is a difference. Sole traders (or sole proprietors) are one of three legal forms of private business in the UK. The other two are partnerships and companies. Self-employed is the term given to both sole traders and partnerships (effectively two or more sole traders).
If you’re thinking about setting up on your own and haven’t already registered as a sole trader with HMRC, you can find out how to set up as a sole trader here.
>See also: What is a sole trader? A small business guide
What is bookkeeping and why is it important?
Bookkeeping is the process of keeping accurate records of the financial activities of your sole trader business – in simplest terms – keeping track of the money your business makes and spends and keeping tabs on how much cash you’ve got in the bank.
Accurately and regular bookkeeping is important because it helps a sole trader to:
- Keep track of overall profitability as well as understanding which parts of the business are less profitable than others
- Ensure they have accurate records as proof of expenses incurred and to help support and submit their self-assessment returns
- Plan for tax liabilities and avoid unnecessary penalties
- Budget for expenses
- Manage cashflow
- Keep track of revenue to ensure you register for VAT when you need to
- Calculate their VAT liabilities (if they’re VAT registered)
If you’re VAT registered, unless you register for Flat Rate VAT, your bookkeeping will get a bit more labour intensive as you’ll need to track and record VAT paid on relevant expenses.
>See also: Sole traders and VAT
What is difference between bookkeeping and accounting?
Bookkeeping is the day-to-day processing of your financial transactions. Accounting is the process of taking that information and either reporting or analysing it – for example submitting your tax return as well as ensuring the records comply with traditional accounting methods. The good news is that as a sole trader, if your income is less than £150,000 per year – you can adopt what’s called the cash basis, which means you only have to keep track of income and expenses as and when they received or paid.
What records do I need to keep and for how long?
You should keep records of:
- Money you make and spend (income and expenditure) and all the relevant receipts and invoices
- Any grant income you receive and any relevant calculations
- Any other personal income (for your self assessment tax return)
- All payroll records if you’re an employer
There used to be a lot more flexibility as to the format of your records, which meant you didn’t have to use accounting software and could instead keep track of your records on Excel or paper, but as of April 6 2024, the implementation of Making Tax Digital for Income Tax Self Assessment (more on this below) means that all sole traders will need to keep digital accounting records and will have to start using some form of accountancy software.
You need to keep your records for at least five years after January 31 following the end of your tax year. So, for the year ended April 5 2022, you’d need to keep these records until January 31 2028.
What do I do with my invoices and receipts?
You should always ensure you have the relevant receipts and invoices to support any expenditure to support your tax returns if HMRC gets in touch. You don’t need to keep paper copies as long as you’ve got them stored digitally (and are backed up). We also recommend attaching these receipts and invoices to the relevant record in your accounting software. This might seem like a hassle, but if you ever have an enquiry from HMRC or your accountant needs to check something – if your receipts are in a shoebox or in your emails, the only person who can deal with these queries are you. Having receipts and invoices attached to the relevant transaction in your accounting system means you always have the information to hand and avoid a potentially big headache.
Making tax digital and accounting software
You’ve probably already heard of Making Tax Digital. It’s been around a few years now, but up until now it related to VAT. The next phase of Making Tax Digital will apply to sole traders. Making Tax Digital for Income Tax Self-Assessment (aka MTD for ITSA) will be the new way of reporting self-employment and property income to HMRC and will apply to sole traders with business income of more than £10,000. From April 6 2024, instead of filing an annual self-assessment, you’ll need to use MTD compliant accounting software to keep track of your financial records and submit quarterly income tax updates to HMRC. You can find out more details here. Partnerships won’t need to do this until April 2025.
What is the best accounting software for sole traders?
You’ll never be short of accounting software providers to choose from.
Whilst it can be tempting to go with the cheapest or free one, make sure you do your research first so you can find something which not only helps you keep accurate records but also helps you save time and make better business decisions. The advantage of going with something like Xero or Quickbooks is that you’ll never be short of people who know how to use it. There are however lots of other providers to choose from. Some banks like Natwest also support small businesses by giving free access to FreeAgent.
Start by asking fellow sole traders and find out what they use and what they like about it – remember thought that what is right for one sole trader might not be right for another.
Does it have the functionality you need or want?
- The ability to upload receipts or invoices easily or integrate with something like Dext or Hubdoc. To save time you should looking for uploads that include OCR (which means it reads the invoices and pre-populates lots of fields
- Integration capabilities – in your business you might use other software for your sales or stock management so you will want to find software that can integrate with this
- Automatic bank feeds with your bank
- Budgeting – if you can put a budget in your accounting software, you’re more likely to keep tabs on how well your business is doing so you can adapt as and when needed
- Reports – can you report on the information you need in your business or does it have the flexibility to adapt reports to do this?
- Most importantly, is it MTD compliant?
Try a free trial – how does it feel? Is it intuitive? What is the support like?
Do I need to set up as separate bank account for my business?
Although you don’t have to, having a separate bank account for your self-employment will make your bookkeeping a lot less complicated and means you don’t have to filter out all your personal expenses. Some sole traders even set up two accounts so they can set aside savings for their tax liabilities as and when they fall due.
What expenses can I claim?
The rules for sole traders are different to limited companies but if the expenses are “allowable” per HMRC, you can offset them against your self-employed income to work out your taxable profit. Full details can be found on the HMRC website.
Tip: Beware of advice from a fellow business owner – they might be well meaning, but you could end up being misinformed unintentionally and claiming things you shouldn’t.
What taxes do I need to pay and when?
Income tax
- As a sole trader, you pay income tax on your taxable profit. This is currently reported on a self-assessment tax return for each tax year (ending April 5) but will soon be submitted digitally under MTD ITSA. Payment is due by January 31 following the end of the tax year.
- If your self-assessment tax bill (including Class 4 National insurance) is more than £1,000 you will also have to make payment on account for the next tax year (January 31 in the tax year it relates and by July 31 after the tax year it relates to)
National Insurance
- If you’re self-employed – you will usually pay two types of National insurance – Class 2 and Class 4, subject to the amount of taxable profit you make. The amount you need to pay will change every year so always best to check out the GOV.UK website for up-to-date rates
- This will be payable at the same time as your income tax
VAT
- If your taxable income exceeds the £85,000 threshold in any 12-month rolling period, you’ll also need to register for VAT. A lot of sole traders get caught out because they assume it’s their tax year. You need to register for VAT if you exceeded the threshold in the last 12 months or know you’re going to exceed it in the next 30 days
- VAT returns are usually done on a quarterly basis and are due (together with payment) one calendar month and seven days after the relevant VAT quarter
PAYE and National Insurance
- If you hire staff, you’ll need to register as an employer and will then need to collect PAYE tax and employee insurance from your employees and pay this together with employer National Insurance to HMRC on either a monthly or quarterly basis. For most self-employed businesses, their employer National Insurance is often reduced thanks to something called Employment Allowance which helps eligible businesses to reduce their annual employer national insurance liability by up to £5,000.
As a sole trader, do I need an accountant or bookkeeper?
Not necessarily. If you’ve got the time, inclination and brain capacity, there’s no reason why you can’t do it yourself but it’s worth getting some initial training upfront or finding someone who can review what you’re doing to ensure you’re on the right track and doing things correctly.
If you decide you want to get a bookkeeper or accountant to help, make sure you don’t just go for the cheapest option. Do some research, make sure they’re qualified, look at reviews, ask for recommendations and speak to them in person. You need to feel comfortable working with them and know they’re going to support you and your business in a way that suits you.
Bookkeeping tips if you’re a sole trader
- Don’t leave your bookkeeping until the last minute
- Keep money set aside for your income tax and National Insurance – putting aside 30 per cent of taxable profit should cover this with a bit left over
- Know your tax deadlines in terms of filing and payment
- Check out the GOV.UK website for videos, live webinars, other support or to receive email updates
- Keep an eye on your cashflow. It doesn’t matter how much money you make if you run out of cash to pay debts when they’re due.
- Don’t just do bookkeeping because you must – do it because it will help you and your business. If you really don’t get it/don’t have the inclination or time – find a bookkeeper
- Make sure you have appropriate insurance
- If in doubt, always seek professional advice from an accountant or bookkeeper
Kate Gloudemans is co-founder of Sprout Consulting, which provides accountancy support services and strategic business advice to ethical, sustainable and purpose-led businesses
More on bookkeeping if you’re a sole trader
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Timothy Adler, Khareem Sudlow
