2. How Do Accounts Work?

You will hopefully be relieved to know that I am not an accountancy expert. You do not need to be one either. If you have run a business before, or even been involved in one on the financial side, then you probably have a good idea of basic accounting already. In which case, you can skip this section (and possibly this chapter) as it applies to people who have no previous experience and/or knowledge of putting together accounts for their business.

At the risk of stating the very obvious, here is how your finances should work.

• You charge clients money for the work you do, usually by means of an invoice, and this provides income for your business. Copies of your invoices, plus a note of when they were paid, form the basis of your income records.
• You also spend money on behalf of your business, on travel, equipment, stationery and so on. Generally your accountant and/or the taxman will need to see a receipt as proof of expenditure.
• You need to keep a record of all your income and all your expenditure in a cash book which contains the date and amount of each transaction, along with how it was paid and what it was for.
• At the end of your business year (which runs for 12 months but need not be the same as the calendar year) the sum of all expenses which are allowable against tax (which is not necessarily all your expenses) is deducted from the sum of your income.
• What is left is your net profit. The taxman works out how much you owe in tax based on this amount.
• The way you are taxed depends on what type of business you run: sole trader, partnership or limited company.
• As a sole trader, if you want, you can get the taxman to work out how much you owe. To do so, you need to submit a tax return by 30 September following the year being assessed and tick the section saying you want the tax calculation done for you.
• Alternatively you can work out the amount you owe yourself (or, more likely, get your accountant to work it out). In this case, you can complete the return online or get your accountant to complete a tax return and submit it to HMRC by 31 January following the year being assessed.
• The taxman will then check the calculation and send you a bill.
• But you must pay what you think you owe (according to your own or your accountant’s calculations) by 31 January following the end of your financial year, regardless of whether you have had a bill or not.
• If you do not pay, you could be liable for a fine plus an interest charge on the amount the taxman thinks you owe.
• HMRC will assume your tax bill is going to stay the same in the following year and ask you for two payments on account, each of half the total.
• The first payment on account is due on 31 January following the year of assessment – the same date as your tax bill is due.
• What this means is that your first tax bill will not just be for your first year’s tax; it will be for one and a half times that amount.
• The second payment on account is due by 31 July. At the end of your next financial year, the amount you have paid on account is offset against what you owe in tax. So if your tax bill has gone down, you may get a repayment from HMRC. If there is a significant decrease in your taxable profits you can ask the taxman to postpone the second payment on account.
• If your business is a partnership, you (or your accountant) will also need to prepare a partnership tax return which shows how much taxable income was made by the partnership and how it was split between each partner. Each partner still needs to complete a tax return.
• In other respects, partnership finances are similar to those of a sole trader. Payments are calculated in the same way and due at the same times.
• If you run a limited company and it falls within the Companies Act limits of a small company (which it almost certainly will, or else you would not be reading this book for advice), your accounts need to be prepared in the statutory format probably by an accountant. A copy must be sent to Companies House within 14 days of them being approved by the board of the company and within ten months of the company’s year-end. Failure to do this is an offence for which directors can be held liable, and prosecuted.
• A limited company is liable for tax separately to its owners and employees. Corporation tax is a complex affair and it is always worth getting expert advice in relation to it.
• Value Added Tax is levied by HMRC and is completely separate from income and corporation tax. There are more details on how to deal with it later in this chapter.
• National Insurance Contributions (NICs) are yet another levy which you have to be aware of. If you are self-employed, either as a sole trader or within a partnership, then you have to pay Class 2 NICs, which are a fixed amount payable quarterly or monthly by direct debit, plus Class 4 NICs, which are calculated as a percentage of your profits between set limits.