The complete guide to small business accounting
Building and managing a successful business requires an understanding of small business accounting.
Why is that?
It equips you with vital information you need to make better decisions about your business operations, strategy, and growth plan, both large and small.
This guide will teach you how to organize your small business accounts. You'll learn the basics of accounting, how to use this knowledge to your advantage, and the purpose and importance of those tasks.
What is small business accounting?
Accounting involves identifying, recording, measuring, and interpreting financial information for small businesses.
You can monitor your profit and loss by keeping track of your financial records, expenses, and revenue. Additionally, it helps you manage the value of your assets, liabilities, and equity.
Your accounts must accurately reflect this information to ensure you can manage your cash flow effectively. Besides understanding what small business accounting is, it's crucial to understand why it matters. As with any measurable data stream, accounting helps you plan, evaluate, and optimize your business overall.
You can benefit from small business accounting in the following ways:
Maintaining a business budget helps you align your spending with your goals, forecast your earnings, and hold yourself accountable.
Budgets, for example, allow you to determine which resources are essential and which are optional, so you avoid spending money on assets that are unnecessary or 'nice to have'. Furthermore, a well-planned budget can help you obtain funding or raise venture capital since it gives potential investors a clear picture of your spending needs.
The decision-making process
As a business owner, accounting plays a key role in most high-level decisions.
In order for a business to survive long-term, maintaining a healthy cash flow is crucial. Financial reports can help you identify potential areas where you can make adjustments to increase cash flow if you run into cash flow problems.
If you want to increase your profit margins, you may have to change the price of your products or find a new supplier with lower costs.
In either case, having organised and current financial information allows you to assess a problem (or an opportunity) and make better decisions.
Achieving business goals
You can determine if you are achieving your financial goals by analyzing your key performance indicators (KPIs). You won't be able to determine if you should pivot on your strategy or optimise your goals without these reports.
It would be considered a win if, for example, you set a revenue goal for £100,000 in your first year of business. Meanwhile, if you ended up spending three times as much as you planned, you may actually have lost more money than you brought in.
You can use financial reports to assess not only your business's performance, but also whether your short- and long-term growth goals are aligned.
Getting started with small business accounting doesn't require you to be a finance expert. Here are seven basic principles to help you get started.
1. Set up a separate business bank account
As a limited company, you must have a separate account for your business finances. It is recommended to keep these separate if you are a sole trader, even though it isn't legally necessary. Your personal bank account's terms and conditions may specify that it may be closed if it is used primarily for business purposes.
Getting your business account in order requires two simple steps:
Choose a business account. Take into account factors such as transaction fees, withdrawal fees, introductory offers, customer support, and admin features when selecting an account.
Set-up a savings account. Organizing your funds and planning for taxes will make life easier for you. Set up a separate savings account for tax payments if you are self-employed.
Your business account should have a variety of features that make managing your finances easy. Zyla Accountants can provide advice on which accounts offer the best value for your business when you're ready.
2. The benefits of working with an accountant
Due to the many hats entrepreneurs wear, company accounts can often be neglected. You can run into problems down the road if you make any accounting mistakes.
Accountants can make your life easier for a number of reasons:
By keeping accurate records, you can track cash flow and forecasting, which can help you make smarter business decisions (as mentioned above).
A well-organized bookkeeping system will make tax season much more enjoyable (especially for cash flow positive businesses).
By spending less time on bookkeeping, you can focus on building and growing your business.
Accountants help you with everything from forecasting to tax audits, loan applications to VAT registration.
To choose the right accountant for your business, you should identify your business needs, look into the accountant's fee structure, and obtain an engagement letter. In most cases, accountants charge flat monthly fees for their bookkeeping and accounting services.
3. Track your expenses
Keep track of your expenses and outgoings at all times. When you neglect your expenses, you may run into problems with your cash flow (especially in the beginning).
What is an expense?
In order to generate revenue, you incur expenses. Essentially, it is your operating cost.
From employee salaries to materials for making your products to marketing expenses, you have to spend money to run your business.
Before your company's income is taxed, you can deduct business expenses. Accounting not only saves you headaches, but money as well (we'll discuss what you can claim in a moment). To claim this tax relief, you must keep accurate records of every single business expense for up to six years.
Why is it important to track your expenses?
Keeping track of your expenses may sound difficult, but as mentioned above, advanced business accounts (and most online accounting software) do it automatically.
Tracking your expenses gives you an understanding of how you spend your money and could help you claim some of it back.
By controlling your outgoings and identifying what you're spending your money on, ultimately you're able to save money and invest in other areas of your business (such as marketing).
How can you claim business expenses?
It is often difficult to understand this area. In order to clarify, here are some examples of what can be claimed as an expense when doing your small business accounting:
Labour. In this category are full-time employees, independent contractors, consultants, and freelancers.
Rent, utilities, phone and supplies. Rent, bills and other office expenses can be deductible as a business expense. If you work from home, a percentage of your bills and rent can be claimed against the business.
Business travel. If the purpose of a trip is for business (e.g. meeting suppliers or clients), then you can claim it as an expense.
Transportation. Record when, where and why you used any vehicle for business and keep any rental receipts.
Benefits, education and training. If you offer your employees dental insurance or the opportunity to further their education or learn new skills, these can be deductible business expenses for you and/or your employees.
Entertainment. Employees (including you) can claim £150 per year for entertainment. You can claim £150 per guest (including VAT) if you host a holiday party for your employees. Sole traders cannot claim entertainment expenses.
Food. Client lunches are deductible at 50%, as are employee lunches taken while traveling for business.
What cannot be claimed as business expenses?
The following expenses are not deductible as business expenses:
Fines and penalties. Failure to file by the due date and late payments are the most common fines for small business owners.
Political contributions. Contributions your business made to a political party or candidate cannot be deducted.
Hobby related expenses. Dues paid to a country club, social club, or fitness facility are not deductible business expenses.
How to keep track of your expenses?
As soon as you start your business, set up a system for keeping records and receipts.
For tracking expenses, many small business owners just starting out use expense spreadsheets. We recommend automating as much as possible using online software as your business grows. If you can do this at the start, it will help in the long run!
How can I track employee expenses?
Tracking your employees' expenses is a key part of keeping a budget, monitoring their spending patterns, and reimbursing them if they incur out-of-pocket expenses.
Creating a clear and transparent company expense policy is the first step.
In step two, ensure that employee expenses are being managed efficiently.
The third step is to streamline your operations by adopting modern expenses solutions. Employee expenses are made easier with company expense cards if your bank provides one.
What is the best way to organize your expenses?
Decide which small business accounting method you will use to organize your expenses next. Methods include:
Cash method. Expenses and revenues are recognised at the time of receiving them.
Accrual method. Revenues and expenses are recognised when a transaction occurs (even if the cash hasn't yet been received or paid) and require tracking receivables and payables.
When your business has a turnover of £150,000 or less, cash basis accounting is a good method to calculate your income and expenses for your Self Assessment tax return (if you're a sole trader or partner).
4. Set up an invoicing system
The heart of your small business accounting is an effective invoicing system. Invoices are prepared based on the products or services sold and must be accurate and timely. Cash flow and peace of mind benefit from sending your invoice as soon as possible.
What is an invoice?
It is a document sent by the provider of a service or product to the purchaser. By establishing an obligation to pay on the part of the buyer, the invoice serves as a verification of the agreement between buyer and seller.
It is important not to confuse an invoice with a receipt or a purchase order, as each is designed for a specific purpose. Make sure you understand whether or not you need to include VAT on an invoice, and if so, how to do so.
Automate your invoicing process
Online invoicing allows you to send invoices directly to customers without paying for postage. Additionally, it allows clients to pay online easily.
What to include on an invoice
As a minimum, your invoices should include:
A unique identification number
The date of the invoice
The date the goods or service were provided (supply date)
The client’s name (or business name)
The client’s email address
The client’s address
Your name (or business name)
Your business address
Your contact details
A clear description or an itemised list of product/services
Costs for each item
VAT amount if applicable
Total cost/amount owed
Your preferred payment method
At the bottom of the invoice, you can include your BACS or account details.
5. Establish payment terms
When and how you'll be paid depends on your payment terms and policies. As a freelancer, you should discuss this with your clients and set expectations. In this way, they won't be surprised when they receive an unexpected bill.
Prepare for late payments
There is a possibility that you will encounter a client who fails to pay you on time at some point. No matter what happens, remain calm. This can be a huge issue for a small business.
Make it easier on their own cash flow by extending their deadline or suggesting a payment plan. In order to prevent it from happening again, you can also implement late penalty fees when the invoice is past its due date.
Some banks offer invoice chasing and auto-matching so you don't have to worry about anything. Rather than manually following up with clients or customers, simply schedule auto-reminders and then sit back and wait to be notified when the bill is paid.
Example payment terms
Having trouble finding a payment option that works for you? The following are four of the most common payment terms. Based on your business model, choose one of the following:
DOR or Due On Receipt. Ensures your invoices are paid on time since the money can come to your account instantly.
PIA or Payment In Advance. This is a payment that’s made ahead of schedule for your products and services.
EOM or End Of Month. The payer must issue payment within a certain number of days following the end of the month.
COD or Cash On Delivery. This means goods will be paid for on delivery.
6. Set up a bookkeeping system
You may hear the terms bookkeeping and accounting used interchangeably when setting up your small business accounts.
However, there is a big difference between the two. A bookkeeper records financial transactions, whereas an accountant categorises, analyses, and summarises them.
How to track your company records
For tracking your business expenses and goods and services sold on a monthly basis, you can use free alternatives if you are not ready to invest in accounting software.
Xero, QuickBooks and Sage are accounting platforms that automate various bookkeeping tasks for you. Zyla Accountants can help you get setup with the software quickly.6. Determine your business's tax liability
It is common for small business owners to feel overwhelmed by the burden and complexity of accounting for their businesses.
Tax returns can be confusing and scary to file. You'll be fine as long as you do it on time. It is easy to fix a missed deadline by informing HMRC of your circumstances.
There may be different types of tax you'll have to pay depending on your business.
How to calculate your tax if you’re a Sole Trader
Work out whether your income is taxable or not
Work out the allowances you can deduct from your taxable income or your final tax bill
Work out at what rate your income is taxed
Consider whether you can deduct anything from your tax bill
If you are registered as a Sole Trader, you must pay Income Tax through HMRC’s Self Assessment tax return.
How to calculate your tax if your company is registered as a Limited Company
Corporation Tax must be paid by Limited Companies through HMRC's Company Tax Return.
The difference between Corporation Tax and Income Tax is that companies do not have a personal allowance. Whenever your business starts making a profit, you must start paying Corporation Tax at the Corporation Tax rate (unless you've previously lost money).
All this can be calculated for you by a good accountant. As a business owner, however, it is helpful to understand how everything works.
7. Determine if VAT registration is required
If your annual turnover (sales) exceeds £85,000, you must register for value added tax (VAT). If your turnover is below that threshold, registration is optional.
Thus, you will charge your customers 20% VAT, which means adding 20% to your invoices and keeping this amount aside. The VAT you paid on business-related purchases and expenses can then be reclaimed. The net amount of the two must also be paid to HMRC. Quarterly VAT returns and payments are due.
How can business owners make their small business accounting easier to manage?
In light of the government's Making Tax Digital initiative, cloud accounting tools like Xero, QuickBooks, and Sage are now the norm for most businesses. It can be difficult to decide which accounting package to use with so many options available.
Set up some trial accounts to see which tools are easiest to use and best fit your needs before buying. Afterward, you'll be in a better position to make a decision.
Also consider other apps and add-ons that can connect to your accounting software and help you save even more time.
If you have an accountant, they should be able to help too. These days accountants are a lot more tech-savvy – yes, they can look after your tax returns, your bookkeeping and your company’s legal structure, but they can also provide advice around areas like software, funding and cash flow.
Looking after your cash flow is critical, during normal times and exceptional ones. But in between your daily responsibilities, your cash situation can go overlooked, especially when you’re under pressure.
Your business's cash flow refers to the money flowing in and out. Your business is probably in good financial shape if the cash coming in is greater than the cash going out. Maintaining a positive cash flow isn't easy.
Start by making sure the money coming in is reliable and consistent. Morrisons, for example, has paid their smaller suppliers immediately during the pandemic to help at-risk businesses. You may be able to negotiate more favourable payment terms with your customers if you offer a similar arrangement.
Invoice chasing tools make it easy to recover money locked in unpaid invoices with Direct Debit tools like GoCardless. Make sure you regularly review non-essential expenses flowing out of your business as well.
Keeping track of your business's cash flow is the best way to stay on top of it. Creating a cash flow forecast the traditional way can take hours. Even the most complicated spreadsheets can't account for the constant changes in your business' finances.
An automated tool that generates a forecast in minutes based on your data makes things a lot easier. Further, it's always up-to-date, syncs easily with your other accounting software, and can even help you access financing.
It's not as complicated as you might think to manage your small business accounts. It is easier to keep track of your books if you are organized.
You can always get help from a chartered accountant if you need it. And Zyla Accountants is here to help, if you do.