If you are already one of the 3.1 million sole traders in the UK, you are aware that there is an extremely daunting amount of information and tasks that are your responsibility as a business owner. Bookkeeping is a duty that many sole traders would rather avoid doing since they are so busy managing the various responsibilities that come with being their own boss and running their own business.
Whether you already run your own business as a sole proprietor or are considering going into business for yourself and becoming self-employed, swatting up and learning more about bookkeeping for sole traders, becoming familiar with the terminology, and putting a good bookkeeping process into place is one of the most helpful things you can do to assist your company. This is true whether you already run your own business as a sole proprietor or are thinking about going into business for yourself.
‘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?
There is a distinction between these two phrases, despite the fact that they are frequently used synonymously to refer to those who are self-employed. In the United Kingdom, a sole proprietorship, sometimes known as a sole trader, is one of the three legal types of a private company. Partnerships and corporations make up the other two types. Both lone traders and partnerships are referred to be self-employed when using this phrase (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.
What is bookkeeping and why is it important?
Bookkeeping is the practise of keeping accurate records of the financial operations of your lone trader firm. In the simplest words, bookkeeping is keeping track of the money that your business generates and spends as well as keeping track of how much cash you have in the bank.
It is crucial for a lone trader to manage their books in an accurate and regular manner since it allows them 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.
What is difference between bookkeeping and accounting?
The processing of your financial transactions on a day-to-day basis constitutes bookkeeping. Accounting is the process of taking that information and either reporting or analysing it – for example, submitting your tax return as well as ensuring that the records comply with traditional accounting methods.
Accounting is also the process of ensuring that the records comply with traditional accounting methods. The good news is that if you are a sole proprietor and your annual income is less than one hundred fifty thousand pounds, you are eligible to use what is known as the cash basis.
This means that you are only required to keep track of your income and expenses at the time that they are 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
You used to have a lot more leeway in terms of the format of your records, which meant that you didn’t have to use accounting software and could instead keep track of your records on Excel or paper. However, as of April 6, 2024, the implementation of Making Tax Digital for Income Tax Self Assessment (more on this is provided below) means that all sole traders will be required to keep digital accounting records and will have to begin using some form of accountancy software. This applies to those who keep their records on paper as well as those
You are required to maintain your records for a period of at least five years following the January 31 that comes immediately after the close of your tax year. Therefore, you would need to preserve these documents until the 31st of January 2028 for the year that ended on April 5 20222.
What do I do with my invoices and receipts?
In the event that HMRC comes in touch with you, you should always make sure that you have the required receipts and invoices to support any spending in order to support your tax returns. As long as you have a digital copy of the document, you do not need to maintain any hard copies of it (and are backed up). Attaching these receipts and invoices to the appropriate record in your accounting software is another best practise that we advocate. If your receipts are in a shoebox or in your inbox, the only person who can deal with these enquiries is you. This may seem like a bother, but if you ever have an inquiry from HMRC or if your accountant wants to check something, the only person who can deal with these queries is you. You may eliminate a potentially significant amount of hassle by keeping copies of any necessary receipts and invoices associated to the relevant transactions in your accounting software. This ensures that you always have the information you need at your fingertips.
Making tax digital and accounting software
It is likely that you are already familiar with the Making Tax Digital initiative. It has been there for a while, but up until recently, it was mostly concerned with VAT. The second phase of Making Tax Digital will focus on single proprietors and independent contractors. Making Tax Digital for Income Tax Self-Assessment, often known as MTD for ITSA, is the new method that will be used to report income from self-employment and property to HMRC. This method will apply to sole traders who bring in more than £10,000 annually from their businesses. You will no longer be required to file an annual self-assessment after April 6, 2024; instead, you will be required to utilise accounting software that is MTD compatible in order to maintain track of your financial records and report quarterly income tax updates to HMRC. You’ll be able to get further information by reading this. Not until April 2025 will partnerships be required to complete this step.
What is the best accounting software for sole traders?
There is no dearth of options available to you when it comes to accounting software vendors.
Even though it may be tempting to go with the option that costs the least amount of money or is free, you should make sure to do your research first so that you can find something that not only assists you in maintaining accurate records but also assists you in reducing wasted time and improving the quality of your business decisions. If you decide to go with a programme like Xero or Quickbooks, you won’t run out of individuals who are familiar with how to use it, which is a significant advantage. Despite this, there are a multitude of additional service providers from which to select. Free access to the accounting software FreeAgent is provided by several financial institutions, such as Natwest, to show their support for small businesses.
Ask other sole proprietors what they use and what they appreciate most about it. Keep in mind, however, that what is appropriate for one sole proprietor may not be appropriate 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?
Having a separate bank account for your self-employment will make your bookkeeping a lot less difficult and will save you from the need to separate all of your business and personal expenditures. However, you are not required to get such an account. Some people who operate their businesses on their own even open two separate bank accounts so they may save money for their tax obligations when they come due.
What expenses can I claim?
The regulations that apply to sole traders are distinct from those that apply to limited businesses; nonetheless, if the costs “allowable” according to HMRC, you are able to deduct them from your income from self-employment in order to determine your taxable profit. On the website of the HMRC, you may get all of the relevant information.
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?
Certainly not in every case. There is no reason why you shouldn’t be able to do it yourself if you have the time, the inclination, and the mental capacity to do so. However, it is highly recommended that you either get some initial training up front or find someone who can review what you’re doing to make sure that you’re on the right track and doing things correctly.
If you think you might need the assistance of a bookkeeper or an accountant, make sure you don’t just go for the option that offers the lowest price. Do some research, verify that they meet the requirements, check out their ratings, inquire about their recommendations, and talk to them in person. Working with them requires that you have confidence that they will help you and your company in a way that is tailored to your specific needs and preferences.
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
