A guide to setting up and managing finances for the self-employed
1) Cash-basis vs traditional accounting
2) Setting up a business bank account
3) Recording income and expenses
4) VAT registration for the self-employed
5) Self-assessment tax returns
Accounting for the self-employed is the simplest form of accounting, as it just concerns income and expenses. There are many resources available to help you too, from the HMRC self-assessment tax return portal, the GOV.UK website and online accounting software.
Cash basis vs traditional accounting
When you first set up your business you’ll need to decide what kind of accounting system to use. It all depends upon your income and how you’d like to pay income tax on it.
This is a good way to organise your accounts if you run a small sole trader or self-employed business, or are part of a partnership. There is a threshold for cash-basis accounting and your income must not exceed this.
Traditional accounting requires you to declare what you are owed but have not received yet, and what you’ve chosen to spend on but haven’t paid for yet. This refers to unpaid invoices and invoices you’ve not yet paid for.
Your tax return will also include the value of stock, your year-end bank balances, money taken out of the business for yourself and investments in the business. This type of accounting is better suited if you have high levels of stock, require business finance or want to offset any losses.
Read more about the features of both types of accounting on the GOV.UK website.
Setting up a business bank account
Keeping your business and personal finances separate helps you keep track of your incomings at a glance, and see any expenses clearly. If you need to invest in equipment, travel or training taking money from your business account is much simpler, instead of getting mixed up with your personal account. Most banks and building societies offer a simple business current account for sole traders and the self-employed. These include the usual services like internet banking and debit or credit cards.
Recording income and expenses
Accounting for the self-employed is relatively simple if you keep track of your income and expenses on a regular basis. Record any payments from sales, invoices and recurring work using accounting software. The same goes for expenses too – you must record purchases made for your business including equipment, supplies and travel expenses like train tickets. Keep hold of your receipts too, you don’t need to send them to HMRC but they may want to check them.
If you are using cash-basis accounting there are allowable expenses that you can claim for against your income tax. These include:
1) Running costs – electricity, fuel, telecoms, portion of rent or mortgage
2) Admin costs – stationery
3) Equipment – computers and tools
4) Interest and charges up to £500
5) Goods for resale
You must keep records of expenses (and also income) for 5 years after the tax return deadline. Find a list of allowable expenses on the GOV.UK website.
VAT registration for the self-employed
It is quite common for self-employed people to decide to be VAT registered, either because their turnover reaches or exceeds the threshold or to make accounting simpler. You must also register for VAT if it is likely that your turnover will exceed that year’s threshold in the next 12 months.
The flat rate VAT scheme is often preferred by many sole traders, as a simpler way to pay tax. Under this scheme you pay a fixed percentage to your turnover each year, and pay this to HMRC. This means you don’t need to calculate VAT in and out on each transaction you make. Read more on the Bytestart small business portal.
Registering for VAT allows you to claim VAT back on eligible expenses and can make it easier for you to work with certain clients.
Submitting self-assessment tax returns
Self-assessment, commonly completed online, is how you pay taxes and national insurance contributions as a self-employed person. It is simple to register online and you will be sent a login for the portal to where you complete your return.
The tax year is usually 6 April to 5 April and you must complete your tax return by the 31st January the following year. If you haven’t completed a return before it is really important to register well in advance of the 31st January deadline, as it takes time for your login to come through.
Filling in your return involves recording all income, expenses and allowable expenses. You then are given a calculation for tax, national insurance and other payments due, which you can pay online or via bank transfer.
You can submit your return any time after the end of the tax year, paying immediately or up until the 31st January deadline. We’d recommend saving money for tax as you go along and completing your return early, so you don’t get any nasty surprises.
How to manage self-employed accounts with online software
1) Record cash-based deposits
2) Add expenses
3) Connect your bank account to match transactions
4) Produce statements and reports for tax returns, VAT returns and business analysis