Running a business as a sole trader means taking responsibility for its operations, decisions, and functionalities, from inventory management to sales, profit and loss.
It is the simplest business structure in the UK; hundreds of sole traders sprout yearly. However, only one-third of the businesses survive the competition.
One of the primary reasons is the poor accounting system. Before setting up your business to fight competitors, you must learn sole trader accounting.
This blog post will share everything you need to know about sole trader accounting.
Table of contents
- Who is a sole trader?
- What are the accounting responsibilities of a sole trader?
- Can I claim business expenses?
- What are the common accounting mistakes of sole traders?
Who is a sole trader?
If you consider starting your business, being your own boss, and working independently, you have several options.
You can create a business as a sole trader, a limited company, or establish a partnership with someone else. Each of these structures is different and has various approaches, especially accounting and bookkeeping.
When a person runs their own business as an individual and considers themselves self-employed, they must set up a business as a sole trader.
A sole trader is a person who is solely responsible for their business. They must define themselves as sole traders and register with HMRC when they earn over £1,000 from self-employment in a tax year.
They can also pay Class 2 National Insurance contributions fully or voluntarily to get access to benefits.
As a sole trader, you don’t need to register with Companies House, have no shareholders, directors, or partners, and control business operations and direction.
What are the accounting responsibilities of a sole trader?
A sole trader has numerous accounting needs. For example, if you are recruiting employees, you must ensure proper payroll management. Others can be inventory management, revenue management, etc.
Here are some of the typical responsibilities of sole traders in their initial years.
- Open a separate bank account
Sole traders must separate their personal and business bank accounts to avoid mixing up expenses, though not legally mandatory.
While running a business as a sole trader, you and your business are considered the same for legal and tax reasons.
Separate business and personal accounts to avoid messy payments, make record keeping easy, and a proper tax return preparation.
- Keep records of income and expenses
Sole trader bookkeeping includes keeping proof of business income and expenditure, like sale receipts, purchase bills, bank statements, etc.
It helps owners understand their cash flow and set up a budget to keep more money in their pockets.
- Pay the correct taxes on time
Taxes are something no business can avoid. Sole traders must keep track of their income tax throughout the year, as they won’t be taxed via PAYE. They must set aside enough cash to cover their annual tax bill.
Sole traders must pay the following taxes:
- Income tax on your net profit
- Class 2 and class 4 NICs (National Insurance contributions)
- VAT, if turnover exceeds the VAT threshold level, currently £85,000.
Sole traders may be eligible for several tax-free allowances and deductions that they must consider while preparing tax returns.
It helps them reduce tax bills without catching the eyes of HMRC and inviting an investigation.
- Proper bookkeeping
Bookkeeping is vital for any business. It refers to collecting, updating, evaluating, and storing financial transaction data on your books.
Keeping this information handy helps you during audits, lawsuits, investigations, preparing financial statements, etc.
- Creating and analysing financial statements
Once you have financial data, you must create monthly or yearly statements.
On analysing such statements, you can deduce the areas of improvement; your profits increased from the previous year, opportunities, and risks.
It helps you look into business performance over a period.
- Follow government regulations
You cannot miss out on government regulations and tax laws at the local and federal levels. It saves you from fines and penalties that impact business goodwill and may let you shut down at its worst.
If it becomes difficult to deal with business operations and stay knowledgeable about a country’s changing laws, look for a sole trader accountant near me.
Can I claim business expenses?
Sole traders can claim back several business expenses on their tax returns, and HMRC will pay them.
- Equipment cost
- Cost of stock
- Delivery charges
- Heating and lighting in your commercial premise
- Business premise rent
- Postage and stationery
- Relevant books and magazine
- Bank charges and telephone usage
- Travel allowance
- Bank charges and business accounts
However, there are a few expenses that you cannot claim on your tax return.
- Parking fines
- Speeding tickets
- Child care and school fees
- Client entertainment and gym membership
- Hairdressing cost
- Training courses not related to your job
As a sole trader, a few household expenditures may also be included under tax deductibles if you work from home.
Ask your accountant to list such expenses.
What are the common accounting mistakes of sole traders?
Sole traders find it tempting to do their accounting, but they must avoid a few common errors, like:
- Waiting for the last minute to do your bookkeeping and prepare taxes
- Do not have a properly updated accounting system
- Misplacing paper bills and invoices
- Mixing personal and business finances
- Not preparing a proper budget
- Trying to avoid paying the right taxes or missing deadlines
You can avoid making errors in calculation and misplacing paper bills and invoices but automating the accounting system.
Cloud accounting software is a great option for sole traders who are lazy to do manual calculations, have less physical storage for paperwork, have fewer employees, and are prone to making errors.
Sole traders have numerous responsibilities in business, and dealing with accounting needs can be hectic. It is a sensible choice to hire a professional, an accountant, or a bookkeeper and claim back their charges on your tax return.
However, if you are on a tight budget, do your accounting but don’t miss out on it.