Everything you need to know about accounting for your small business

Everything you need to know about accounting for your small business

Feb,2019 By Smarty Software Knowledge Base

Starting a business can be a mind-boggling process. Business ownership is a constant flood of challanging milestones along with expanding to-do lists. With your new venture, you’ll need to get on top of the accounting tasks that come along with running a business.

Author: Reza Bakhtiary, Smarty Software

Accounting can be a daunting subject for a business owner, and to be honest, it’s more than a little boring. When it comes to establishing a business, subjects like increasing revenue and marketing get good press because they are the fun parts but the back-end stuff like accounting can’t be overlooked.

Accounting is an important part of any SME business. However, you don’t have to go get a degree in accounting in order to successfully develop your business. There are a few essentials that you should know though, to ensure that you’re making the best decisions for your small business accounting drill.

This article will guide you through basic accounting knowledge and will give you the confidence to know you’ve covered everything you need to learn about accounting and you will be ready to move on to the next item on your business to-do list.
 

Accounting and its Importance

Simply put, accounting is the function of organizing the financial data in your business. The accounting procedure is a critical function of business as it reveals financial inconsistencies and redundancies, which could lead to better business actions. Having complete, precise, and properly executed accounting process can make the difference between business success and failure.

Starting a business often requires entrepreneurs to master and accomplish a variety of business objectives. An important business objective when starting a small business is accounting. Although many entrepreneurs may be fearful of dig up through endless stacks of financial documents. Accounting often provides entrepreneurs with a crystal clear picture of their business’ success. Entrepreneurs must also keep copious amounts of financial records regarding the small business start-up for tax and legal purposes.

Accounting words every business owner should know:

Entering the accounting field can be a little confusing at first with all the new terminology to grasp. Learn these essential accounting terms and master your bookkeeping.

Account

Accountants use accounts to keep business numbers organised. Think of them like buckets within your business—all the money that flows through your business needs to be categorised somehow—that’s what accounts are used for.

Accounting

In every business, money comes in and money goes out. Accounting is nothing more than tracking the when, who and how much of money flowing through your business, and then reporting it.

Assets & Liabilities

Both accounting and financial words, assets and liabilities appear on your Balance Sheet. An asset is anything your business owns. Examples are cash (money in the bank), accounts receivable, inventory, a loan to an employee, equipment - any tangible thing that your company holds. The cost of an asset is not deducted on your Profit & Loss Statement.

A Liability is something you owe to someone else. Examples are accounts payable, equipment loans, tax liabilities – basically anything you owe. Unless liabilities exist for a specific or strategic reason, you want to keep them to a minimum. The payment of a liability is not deducted on your
Profit & Loss Statement.
To win in the game of business, you want to grow your assets and shrink your liabilities.

Debit & Credits

Debits & Credits are accounting-specific words and represent entries in your General Ledger (the chronological list of every financial transaction in your “books”). Credits appear on the right side, and Debits appear on the left side of your General Ledger. For every value posted as a Credit, there must be a balancing entry posted as a Debit. Unless you are in the accounting business, this is all you need to know about this.

Double-Entry Accounting

Double-Entry Accounting is also known as “Real” Accounting. Double-entry simply shows both sides of any transaction. Here’s an example: You take money from your checking account to buy something for your business, let’s say a printer for $100, then you're going to debit the checking account for $100 and credit your related expense account for $100. In summary, you took $100 from one account and tracked the other side of the transaction, giving it to another account.

Every financial move you make affects your Balance Sheet. Double-entry accounting assures that every transaction is completely recorded to maintain balance.

Income Statement (aka Profit & Loss, P&L)

Your income statement reports your income and expense results from business operations for a set period of time. It tallies the income you bring in and the expenses that go out. This report is commonly produced on a monthly basis, and again on a quarterly basis. An annual income statement, along with other financial reports, will be used to produce your annual income tax return. It can be generated to display this year’s period next to last year’s for comparison purposes. It’s the bottom-line indicator of how your business did for the period chosen.

Expense

An expense is anything your business pays for that is deducted in the current period. When expenses exceed income, you are losing money. Losses are paid for by equity. Too many expenses in excess of income, and you’re out of business.

Depreciation 

Depreciation is an accounting method of allocating the cost of a tangible asset over its useful life and is used to account for declines in value. Businesses depreciate long-term assets for both tax and accounting purposes.

General Ledger

Your General Ledger is the recording of all your debits and credits.

Balance Sheet

Your Balance Sheet is a snapshot of your business’ financial position at a given point in time. It represents the balances of Asset, Liability and Equity accounts on the day it is generated and results in the business Net Worth. It provides a picture of how liquid and solvent (flush with cash) your business is or isn’t; how burdened with debt your business is; and what equity the business holds. Many banks will analyse a business’ balance sheet to determine whether or not they will extend financing.

Fixed Costs

Fixed costs are expenses your business incurs on a regular basis that don’t fluctuate month to month with sales. Rent, internet and phone bills are examples of fixed costs. Sometimes you might hear these costs being referred to as “overhead” or “general & administrative” expenses. Bottom-line, it’s a cost that is fixed, and it won’t change based on products or services you sell or don’t sell.

Variable Costs

Variable costs are the opposite of fixed costs. They are costs that change based on the production of income inside your business. For example, if you manufacture and sell wooden sheds, then the amount you spend on wood goes up and down based on how many sheds you sell. This cost for 5 wood is a variable cost because it changes based on your business needs. Tied to sales are commissions, shipping, royalties, etc. Marketing and advertising can be a variable expense if they are not contractually constant and season or situational in nature.

Owner's Equity

As the owner of a business, you basically own the assets inside that business. The equity of the assets in the business is comprised of the total value of the assets, minus the total value of liabilities. What’s left over is called equity. As the owner of the business, you have rights to the equity. This is called Owner’s Equity. From year to year, it adjusts for annual profit or loss and any distributions or dividends paid out to owners.
 
Accounting reports every business owner should use:

A company's financial statements provide various financial information that investors, creditors and analysts use to evaluate a company's financial performance. A great deal of the information conferred in a financial report is required by law or by accounting standards.

Account Statements

You need to review the routine statements provided to you by third parties, like monthly bank statements. Comparison of these statements with your internal accounting reports will quickly reveal faults or fraud. By making sure the deposits you are registering in your accounting system are matching the ones your bank is receiving, and that the payments being made match as well, you can make sure that your accounting processes are accurately reflecting your financial activity.

Sales Tax Report

Keeping track of how much tax your company collected and remitted is very crucial. Having an overview with your tax professional on your Sales Tax Reports and the Sales Tax Returns you are filing will keep this in check.

Income by Customer

Not all customers are similar to each other. Some might be good at paying you in full and on time, others may be a large portion of your overall billing. Getting paid too slow, or not at all by your largest customers or only having a few small paying group of customers is a good way to ensure early retirement. Viewing your income by each customer will help you analyse your customer base and figure out where you need to make improvements.

Expense by Vendor

In most SMEs, your dealers are an extended part of your team. If it weren’t for them, it would be harder to be in business. But knowing with whom you spend most of your money will aid you make smart determinations when it comes to negotiating pricing, delivery, payment terms, etc. It will help you recognise vendor vulnerabilities you may have, or maybe even alert you to when it’s time to start searching for a new or additional provider.

Receivables

Your receivables report shows you money that you are owed by your customers and will reveal who is overdue. Regular attention to this key accounting report will help you identify on-time and late payers, 7 potential problems in your invoicing system, the need for collection activity, and help you execute your cash flow or budget plans. Regularly ignoring this key accounting report will result in never getting paid, early retirement and possible bankruptcy.

Payables

A payables report will assist you keep track of money you owe your vendors, and when that payment is/was due. Remember, paying your bills on time can affect your business credit and influence the relationship you have with your vendors. Let’s say you have an urgent need one day and you call a vendor for help. Who do you think they’re going to go above and beyond for - the guy who never pays his bills or the “partner” who watches his payables and makes sure payments go out on time?

Sales

This report should be prepared to tell you what is selling, who are selling, what they are selling it for, and to whom. This information will guide you to make management decisions about ordering (if you maintain inventories), staffing, receivable financing, manufacturing/production needs, etc.

Income Statement (Profit & Loss Statement)

All of your business operations are summarized on your Income Statement. An Income Statement give you a quick look over your sales and expenses. You can configure this report to represent today, this week, this month, or this year-to-date (YTD). You can configure this report to present on a Cash or Accrual basis – and both of these views can be helpful. Many business owners avoid looking at this report because they are afraid that they won’t like the results. Be honest enough with yourself to look anyway. It’s the only way you can make the management decisions required to get the result you want.

Balance Sheet

The current profitability, creditworthiness, and saleability of your business are all reflected by your Balance Sheet. It presents a snapshot in time of your business’ assets, liabilities and equity. This report can be achieved for today, last week, last month, or any day your business existed and reflects the numbers true to that day. Unlike a P&L, which reflects an accumulation of transactions within the period represented by the report, a Balance Sheet only reflects the value for that day.

What about taxes:

When you’re running your own business, it’s almost a certainty that you’ll have to pay some kind of tax at some point But with so many complicated tax rules currently in place in the UK, it can be difficult to know exactly which ones apply to you or your business, and which types of tax you’ll actually have to pay to HMRC.
 
  1. Income tax

Sole trader tax is paid based on your business’ profit. If you don’t have any other income, such as salary from a job, as well as what your business makes, then you’ll start paying income tax on your business’ profit once it goes over the personal allowance which is £11,850 if you’re under 75.
If you run a limited company business, you could pay income tax on any salary or dividends you take from the company. Whether you pay income tax, and how much you pay, depends on how much you take out.
Income tax kicks in on your salary if it’s over £11,850, you’re under 75 and you have no other income. If your circumstances are different, – say, you have another job as well as working for your own company – then you may start paying income tax on your salary sooner.
If you are paying income tax on your salary, your employer, in this case your own company, will deduct it from your salary under the PAYE (Pay As You Earn) scheme. PAYE isn’t a tax in its own right; it’s a method HMRC use to collect income tax.
  1. National Insurance

While National Insurance is not strictly a tax, National Insurance is money that’s paid to the government, so it’s often referred to as a tax.
Sole traders pay two kinds of NI. If you’re a sole trader, you’ll pay a flat weekly rate of NI called Class 2 NI, unless your business’s profits are under the Small Profits Threshold, which is £6,205.  Class 2 NI is £2.95 per week. If your business’s profits are under the Small Profits Threshold, you can still pay Class 2 NI voluntarily, to protect your entitlement to State Pension and other benefits.  You’ll also pay Class 4 NI once your business’s profits go over £8,424. Class 4 NI is worked out as a percentage of your business’s profit.
If your business is a limited company, and the company’s paying you a weekly sum of £162.01 or more, then it’ll have to deduct Class 1 employee’s NI from your wages and pay that over to HMRC. The company will also have to pay Class 1 employer’s NI to HMRC unless that’s covered by the employment allowance.
  1. Corporation tax

Limited companies pay corporation tax on their profits. There’s no equivalent of the personal allowance for limited companies, so as soon as a company makes any profit, unless it’s previously made losses, it will start paying corporation tax.
Corporation tax is 19 per cent for all companies, and it’s payable nine months and one day after the company’s accounting year end so, for example, a company with a year end of March 31st will have to pay its corporation tax by 1st January.
Remember that sole traders do not pay corporation tax.
  1. VAT

No matter what kind of business you have – sole trader, partnership, LLP or limited company; if your business makes Vatable sales of more than £85,000 a year, you’ll have to register your business for VAT.

‘Vatable sales’ mean sales of goods or services that would have had VAT charged on them if made by a VAT-registered business. VAT might be 20 per cent, the standard rate, 5 per cent the reduced rate, or sometimes even 0 per cent.
  1. Business rates

If your business operates from office or retail premises, then you may have to pay business rates; this is like council tax, but for business properties.

Some premises are automatically exempt from business rates, such as farm buildings, and others may be entitled to business rates relief.
If you run your business from home, you won’t usually have to pay business rates as well as council tax.
The exceptions are:
  • Employing staff who also come and work at your home
  • Selling goods or services from your home to visiting customers
  • You have adapted your home to work there (such as converting your garage or shed to a dog grooming parlour)
  • Your property is part business and part domestic, for example, you run a pub and live above it
 
What you need to know about VAT:

We’re all used to seeing Value Added Tax (VAT) as a common item on many bills and receipts but is VAT relevant for small businesses? Is VAT something that every business needs to charge? What are the pros and cons of VAT registration?

VAT, Value Added Tax, is generally assumed throughout the EU as a percentage charge paid by consumers when they purchasing certain types of goods and services.

Other countries have different names for the same general concept. For example, Australians have the Australian Goods and Services Tax (GST) or in Japan There is a fixed sales tax ("sales tax"), literally translated from Japanese as a "consumption tax". As we provide accountancy services to UK businesses, we’ll stick with talking about VAT.

Since beginning of 2011, the VAT rate in the UK has been 20% for most goods and services. There are some exceptions – for example, children’s clothing and footwear attracts a zero rate for VAT.

Rather than focusing on the details of how VAT is charged, we’re going to look at the broad pros and cons about being VAT registered, so that you can understand what really matters for your SME.

It’s assumed that charging VAT is something that all businesses should do, but in fact, that’s not true. Many SMEs do not need to be VAT registered.

Businesses in the UK need to register for VAT only if their annual taxable turnover in the last 12 months or next 30 days is greater than the VAT threshold. This figure is set and reviewed by the government, with any changes announced in the Chancellor’s regular budget statements.
The current VAT threshold is £85,000 and will be unchanged until 1 April 2020 at the earliest.

If your annual turnover is below the specified threshold, you can still voluntarily register for VAT. It’s completely your call.
You might wonder why you’d want to register for VAT if you’re not legally obliged to.

Registering your business means you have to regularly send VAT returns to HMRC as well as increasing the amounts you charge to your customers. It makes sense that as business owners we want to decrease our paperwork and since it’s a competitive world out there and pricing matters, we certainly don’t want to charge our customers more than we need to.

On the other hand, being VAT registered can make your business more litigable and if most or all of your customers are VAT-registered businesses, the VAT they pay you for goods and services is often reclaimable. Here’s another reason why voluntarily registering for VAT can benefit you. Registering means that your clients and competitors won’t necessarily know what your annual turnover is. However, if you don’t register for VAT, you’re effectively announcing to the world that your annual turnover is less than the VAT threshold.

In many cases, this won’t matter. However, there may be some prospective clients who will feel more comfortable to deal with a VAT-registered business, especially if a big sales opportunity is involved.

We’ve already hinted at the drawbacks of registering for VAT. You’ll need to submit VAT returns to HMRC four times per year and you’ll need to account for VAT on taxable income regardless of who the client is.

If your turnover exceeds the VAT threshold then there is no special exemptions from VAT registration just for sole traders or partnerships. As with limited companies, sole traders have to register for VAT if their annual turnover exceeds the VAT threshold. If your annual turnover falls below the VAT threshold, you don’t need to register for VAT – but you can register voluntarily if you wish.

You can register for VAT via Gov.uk’s VAT registration pages. This applies whether you decide to register voluntarily or whether registration is compulsory because your annual turnover exceeds the VAT threshold.

Once your business is registered for VAT, you’ll gain access to the part of the Gov.uk website that will let you complete your VAT returns. From the VAT point of view, the year is generally split into quarters, meaning that you’ll need to log in to the website four times per year to submit an online VAT return.

You’ll be given a VAT number. You’ll need to include this on all sales invoices you issue from that point onwards. You won’t need to worry about changing or re-issuing any invoices you issued from before the time you were VAT registered. For this reason, it’s important to keep note of your effective date of VAT registration. As well as quoting your VAT number on your invoices, you’ll need to add the relevant VAT charges to your invoices. In most cases, this means adding 20% to the net charge.

At the end of each quarter, you’ll need to log in to the Gov.uk site to complete your VAT return – that’s the point where the VAT you’ve charged is declared to HMRC.

The VAT return is a summary of your earnings (which includes the VAT you’ve charged for your goods and services) plus your expenses (which includes the VAT you’ve paid for goods and services). The difference between these amounts will determine how much you need to pay or claim in your quarterly VAT return.

The summary above covers the most common way of registering for and running your VAT account. There are other methods of handling VAT, including the cash-accounting method and the Flat Rate Scheme. However, if you need advice on which method may be best suited for your small business, that’s something we can discuss during a consultation call.

Remember that the VAT rules are the same across the UK. Thresholds, percentages, forms – it’s all identical. That’s good because we know that our VAT advisory service can offer you the same even-handed advice regardless of where in the UK your business is based.
 
What and how to track income and expenditure

At a high level, your financials are the important reports or statements that offer you insights into the fiscal health of your business. It’s important to know what these are and how they are generated so that you’re aware of how your business is performing at any given time.

Sole traders must maintain accurate financial and they must retain yearly records for six years if they own a limited company. Many business owners begin with a simple process using spreadsheets, while a growing number are now use accounting software.

You can manage your cash flow on spreadsheets, like the kind, you can create in Excel which require a lot of time to create a lot more effort to keep organise and safe or you can go paperless.

Using accounting software to manage and organise your bookkeeping saves time, money and possible human error. Inexpensive software is available to automate record keeping. For example, they can automatically pull transaction records from your bank account so you don’t have to manually enter each transaction.

A superb business reporting solution can take care of all your crucial business information and present it in an at-a-glance view to guide you make the best decisions. You can customise your reporting depending on your priorities at any needed time. You may want a quick daily overview; dig up to whatever is appropriate that day.

Tracking your income and expenses in real-time is a big time/energy saver. In addition, if you have a smartphone, there are plenty of accounting apps available for easily recording income and expenses while on the go. The best apps have features that make keeping up with the details easy, like saving photos of receipts so that you don’t have to keep paper copies.
 
Accounting is necessary in any business. As a small business owner, it’s important for you to recognise that the best practices used by successful companies also apply to you. Following basic accounting principles is essential for success in any size business; Record keeping and financial analysis is key to not only monitoring your expenses but to discovering new avenues of growth. In addition, it will make sure you stay responsible for tax obligations to the government and to your employees.

So what are you waiting for? Begin to manage your finance records.
 

Need Accounting and Invoicing Software?
Sign-up to Smarty Accounting >>



our clients