Setting up as a sole trader: Part 2 – Getting the basics right

As we mentioned in Part 1 of this sole trader series, there are three key stages to the sole-trader business journey:

1. Research and finance
2. Planning and performance, and, finally
3. Support and insight.

We’re going to run you through all three stages over the course of this series of blogs. And to begin with, we’re going to be looking at the challenge of researching and setting up the basic financial elements of your new venture.

The importance of a separate bank account

First things first – if you’re running a business, you’re going to need a bank account for your customers to pay your hard-earned cash into.

The main thing here is to make sure it’s a completely separate bank account from your own personal current account. The high street banks offer basic business accounts at quite reasonable rates (some even waive the bank charges for the first few months). So get yourself a separate account and set it up in your business name.

This is important for more than just cosmetic ‘brand’ reasons. It’s vital to keep your business money and your personal wealth separate and distinct. As a sole trader, you and your business entity are one and the same, so you’re liable for your debts. If the lines are blurred between personal and business money, that’s liable to make your accounting and your annual tax return a LOT more complicated.

Investing capital and assets in the business

Any money that you put into your new business is classed as your ‘investing capital’. In essence, you’re lending the business money to buy the tools of the trade needed to do your job.

Putting money into the business in this way is a sound financial move. These ‘assets’ then end up on your balance sheet – the part of your accounts that takes a snapshot of your current financial position.

What you make in profit defines what you’ll be taxed at year-end. And because the money you’ve forked out for a laptop, or a new delivery van, is now your investing capital, you won’t be taxed again on it. By investing back into your business, you don’t lose any of it to tax – and that’s a great way to reduce the taxable profits you pay to HM Revenue & Customs (HMRC).

Tax and the impact on your profits

Keeping an eye on your profit and loss (P&L) is an incredibly important part of your financial management as a sole trader – remember you’re taxed on the profits you make, which will generally be your total income minus any expenses.

You won’t pay tax on the first £11,500, and anything you earn above this (up to £45,000) will be taxed at 20%. So it’s really sensible to factor this into your planning, and to start putting 20% away for the tax bill you know is coming at the end of the year.

Anything you earn in profit over and above £45,000 will be taxed at the higher 40% rate of income tax, and if your profits peak over £150k (and let’s hope they do!) then you’re up to the additional rate of 45%.

So understanding how much profit you’ve made, how much will be taxable, and what you’ll have to cough up to HMRC is a really important part of making sure your business is on track.

Paying your National Insurance

Because you’re now self-employed, you’ll no longer having National Insurance (NI) taken off your salary each month by your employer. But you do still have to pay that NI – you just do it on a yearly basis.

You usually pay 2 types of NI if you’re self-employed:

• Class 2 if your profits are £6,025 or more a year
• Class 4 if your profits are £8,164 or more a year

Registering for VAT

A big question to consider is whether you need to register for Value Added Tax (VAT). If your turnover is £85,000 you must register for, and start paying, VAT but you can opt to register before this if you want to.

If you deal with the general public, it’s best to avoid early registration. Adding 20% (the current VAT rate) to your prices is likely to put customers off and could have a negative effect on sales.

But if you deal primarily with businesses, sign up early. When you’re in a business-to-business sector, your clients can claim the VAT back – so no-one loses out.

Once you’re registered, you have to collect the VAT element of your invoices, and then pay that money every quarter to HMRC. And, at the same time, you can claim back any VAT you’ve paid out on expenses, new purchases or other costs in the business.

One way to make VAT pay for itself more is to opt for the flat-rate scheme. Rather than paying the variable rates of VAT on different products, you pay a flat rate. You then keep the difference between what you charge your customers and pay to HMRC

It’s a way to make a little profit and make life easier for yourself as a  smaller business.

Setting up an accounting system

If you’re thinking ‘Wow, there’s a lot of numbers involved in this!’, then your next question is likely to be ‘How do I record my income and costs so I can keep a close eye on my money?’

The answer could be something as simple as a spreadsheet – Google and Xero have a financial statement template for Google Sheets that would cover the absolute basics. As a way to get your head around balance sheets and your P&L, it’s a good starting point.

But if you’re really ambitious about getting in control of your finances, we’d definitely suggest getting a subscription to one of the new breed of cloud-accounting packages. For our money, Xero online accounting software is the best package on the market, and ideally suited to the needs of a sole trader who wants their financial management to be top notch.

What you get with Xero is:

• a simple, straightforward way to send out online invoices
• an easy way to record the income you make, and the expenses you spend
• a brilliantly clear overview of all the important numbers in your business.

And because this is cloud software, you can use it anywhere you like – there’s even a mobile app that lets you check your balances, send invoices and record your receipts and expenses.

Your tax is about to go digital

There’s one REALLY big reason to get yourself set up with cloud accounting like Xero – and that’s the imminent transformation of the tax system into the digital domain.

HMRC’s ongoing Making Tax Digital (MTD) initiative aims to have every business in the UK set up with a digital tax account – with VAT registered businesses being the first to be affected, as digital accounts are phased in by April 2019. Non-VAT registered unincorporated businesses (like yours) will join MTD in 2020, which will come around faster than you think. MTD, in essence, means no more hard-copy tax returns. HMRC will simply connect to your accounting software and download the data it needs to work out your tax liabilities.

How *exactly* this will work hasn’t been ironed out, but if your accounts are already in the cloud, in a digital format, you’re already ahead of the game – and that will mean less hassle, fewer conversations with HMRC tax inspectors and an easier life for you!

Planning and performance – the next step

You’ve set up your bank account, invested in some accounting software and registered your business for tax and NI. Nice work!

The next step is to set up a budget and to start creating a workable plan for your enterprise, and we’ll be covering this in our next blog post, so stay tuned.

Who are FD Works?

At FD Works our team of accountants will help you embrace your numbers, get control over your financial destiny and achieve your key goals. We’re based between Bristol and Bath, but work with clients across the UK.