How to Do Accounting for Small Businesses

With so much to think about when starting and running a small business, accounting may not be top of your to-do list, but being aware of your legal requirements and setting up systems to keep on top of your incomings and outgoings will undoubtedly pay dividends. So, what are the need to knows when it comes to small business accounting?

What is small business accounting? 

Small business accounting is how you measure, manage and communicate your business' finances. It consists of several elements, including taxes, management, payroll and inventory. While you may be tempted to simply get your business up and running and work out the financial logistics later, there are a number of things it's worth doing from the start to save yourself time and hassle further down the line.

Accounting basics for small businesses 

Top of the list of tasks would be setting up a business bank account and investing in accounting software so that whatever happens, you can be confident your financial records are always accurate and up to date. It's worth shopping around with both of these to find options that suit your needs and meet your budget. You may also consider using a bookkeeper or accountant. They'll be able to provide a whole host of services to take the strain off you, from maintaining the ledger and preparing tax returns to managing payroll and preparing budgets. 

It's also worth making sure you have a system for tracking business expenses from the start. Making sure you have access to these records and monitor expenditure, both for cash flow purposes, and reporting requirements, is essential.

When it comes to cash flow, you must always be prepared for what money you have coming in and going out. Cashflow forecasting is critical as this will enable you to predict and plan for peaks and troughs in your cash balance. It's also a good idea to set realistic and measurable goals so you can track your performance over time and adapt if things aren't going to plan. 

Making Tax Digital 

Whether you outsource some of your financial affairs or not, you must still be aware of any changes that may affect you. This could be anything from new legislation to changing tax rates. One area already impacting VAT-registered small business owners is the UK government's Making Tax Digital (MTD) scheme.

MTD is designed to help businesses eliminate common errors and save time managing their tax affairs by introducing digital record-keeping requirements. Since April 2019, VAT-registered companies with a taxable turnover above £85,000 have been required to follow Making Tax Digital.

From 1 April this year, this has also applied to those below the £85,000 threshold. To comply, all VAT-registered businesses must keep digital records starting from 1 April (or the start of their next VAT period), and they must use compatible accounting software, such as AccountsPortal, to complete their VAT returns through Making Tax Digital. 

Further changes are in the pipeline; self-employed businesses with an annual income above £10,000 will need to follow the rules for Making Tax Digital for Income Tax from 6 April 2024. This makes investing in the right accounting software even more essential. The final stage of MTD, set to be introduced in 2026, is MTD for Corporation Tax. 

Tax for small businesses

One of the areas that can cause the most concern and confusion among small business owners is tax. Getting this wrong can lead to hefty fines from HMRC, so it's important to know what you should be paying and that you pay on time. Again, the right accounting software can help with this, enabling you to create tax reports in seconds and syncing with your business bank account so you can be confident that your records are accurate with minimal effort.

There are a few taxes you'll specifically need to be aware of. These include:

• Self-assessment income tax 

If you're self-employed as a sole trader and earned more than £1,000, a partner in a business partnership, or you earned income from dividends of more than £10,000, you'll have to complete a self-assessment each year to work out how you owe in income tax.

Everyone has a tax-free personal allowance of £12,570, after which you'll be charged the introductory rate of 20% up to £50,271. The higher rate of 40% then comes into effect on earnings between £50,271 to £150,000. There's also an additional rate of 45% if you have over £150,000 in taxable income. If you own shares in a company, you'll also get a dividend allowance of £2,000.

• Self-employed National Insurance contributions 

As a small business owner, you'll also have to pay National Insurance Contributions (NICs) for you and any employees. Employee national insurance will be deducted from your employee's gross salary via PAYE and paid directly to HMRC at no cost to your business. In addition, employer's national insurance will be charged at a rate of 13.8% on the gross salary within certain thresholds. This is not deducted from salaries and so represents an additional cost to your business.

VAT for small businesses

If your annual taxable turnover exceeds the VAT threshold of £85,000, you must register for VAT. You must do this within 30 days of the end of the month when you went over the threshold. You can also choose to register voluntarily if you're below the threshold. Once registered, you will charge your customers at the standard 20% rate of VAT, which means that you must add 20% to your sales invoice values and then keep this amount aside from what your customers pay you. You can reclaim any VAT you have paid on business-related purchases and expenses and pay the net amount of the two to HMRC. VAT returns and payments are due every quarter.

Many small businesses opt for the Flat Rate Scheme, where VAT is still charged at 20% of the invoice value, but VAT is paid to HMRC at a lower rate, dependent upon your sector. The difference is then extra profit for the business. With this option, however, you can only reclaim the VAT on your purchases on certain capital assets over £2,000. VAT can be complex, so it's worth speaking to an accountant about the best option for your specific circumstances.

The key for any small business owner is to be organised regarding your finances. It can be tempting to put things off while you deal with the more pressing matters of running a business, but this will likely only cause problems further down the line. Having the right tools and personnel to support your financial recording and planning is vital, as is taking the time to look at your figures and truly understand where your business is and where you want it to go.

Keeping accurate and up-to-date financial records will mean your business always has solid foundations, and you won't face any nasty financial surprises. Having these systems in place from the start could save you time and money, not to mention the stress that comes from trying to meet HMRC deadlines at the last minute.