A small business guide to bookkeeping

Developing proper bookkeeping habits is vital to ensure you keep track of your company’s finances, and fulfill your tax obligations. Our complete guide to bookkeeping for small businesses tells you everything you need to know before you get started.

What’s the difference between bookkeeping and accounting?

The terms “bookkeeping” and “accounting” are often used interchangeably. This can lead to some confusion, as they refer to two distinct — but connected — business processes.

Bookkeeping is the process by which you record all transaction information relating to your business, to keep track of income and expenses. Establishing thorough and regular bookkeeping procedures is a must for every business, as well-kept books provide a clear picture of your company’s financial position. It’ll also make things a great deal easier if you want to apply for credit, and when the time comes to file your tax return.

Accounting refers to what’s done with the information recorded during the bookkeeping process. An accountant’s role is to analyse and summarise these transaction records, to provide important information about cash flow, profits, and the value of your company’s assets.

5 essential steps to good bookkeeping

1.) Create an accounting system

First up, you’ll need to establish a system by which to record your income and expenses. It’s advisable to opt for accounting software rather than devising a manual system, as accounting software is faster, easier to use, and more accurate. Manual accounting systems also have the disadvantage of being far more vulnerable to security breaches.

Once you’ve settled on an accounting system, you’ll need to decide whether cash basis accounting or traditional accounting is right for your business. Cash basis accounting records income and outgoings at the time the money comes in or leaves the business. Traditional accounting (known as accruals basis accounting) records transactions at the time of invoicing, irrespective of whether money has changed hands.

Cash basis accounting is widely regarded to be the simpler option, and is the preferred choice for many small businesses. With traditional accounting, there’s a risk that you’ll be liable for income tax on payments that haven’t yet been received.

2.) Maintain your financial records

The financial records you need to keep — and how long you’ll need to keep them — will be determined by whether you’re a sole trader or a limited company.

• Sole traders and self-employed persons must keep records for five years
• Limited companies must keep records for at least six years

Sole traders must record all business income and expenses, and evidence to back up this information in the form of invoices and receipts (and other applicable evidence). This information will then need to be filed with HMRC on a Self Assessment tax return.

The record-keeping and filing process is more complex for limited companies. As a limited company, you’ll need to keep the following financial information and file it on your company tax return with HMRC:

• All incoming money and outgoing expenses (including grants and payments from COVID-19 support schemes)
• Details of company assets
• Details of debts the company owes, or is owed
• Value of all stock owned at the end of the financial year (plus stocktaking used to calculate this)
• A record of all goods bought and sold
• A record of who you bought and sold to or from (except retail businesses)

In addition to these financial records, limited companies need to keep a number of business records that will need to be filed with Companies House. You can find detailed information about this on the Government’s website here.

3.)  Keep track of your expenses

Whether you’re a sole trader or a limited company, you’ll need to keep track of your allowable expenses. These expenses will be deducted from your business profits before your tax liability is calculated, thus reducing the amount you’ll owe to HMRC.

It’s essential to record expenses promptly and keep evidence of applicable spending, otherwise you may end up paying more tax than necessary. Some examples of allowable expenses include:

• Travel costs
• Subscriptions for services used by the business
• Meals and entertainment (when necessary to generate business)
• Equipment
• Utility expenses

4.) Budget for your next tax bill

Tracking your income and expenses allows you to budget for your next tax bill by setting the appropriate amount of money aside each month, so you’re not left struggling to pay your bill when it comes due.

Important dates to note:

• The paper Self Assessment return deadline (sole traders) is October 31st following the end of the applicable financial year
• The deadline for filing online is January 31st following the end of the applicable financial year
• Any amount you owe in tax will be due on January 31st following the end of the applicable financial year

Note that businesses in their first year will be expected to pay their first year’s tax bill plus the first instalment of the next year’s bill. Payments can be made via HMRC’s online portal.

5.) Set up a payroll

If your business has employees, you’ll need to set up a payroll. To do this, you’ll need HMRC-recognised payroll software — you can find more information on the Government’s website here.

The process for setting up a payroll with HMRC is as follows:

1. Register with HMRC, as an employer

If you’re the director and sole employee of a limited company, you still need to register with HMRC. In most cases, you’ll receive your employer PAYE reference number in the post, within five days of registration. You’ll also need a PAYE login, which should be assigned when you register online.

2. Provide HMRC with employee information

To do this, you’ll need the following information about each employee:

• Do they need to be paid through PAYE?
• Their tax code (on their P45 or available on the HMRC’s starter checklist)
• Do they have an outstanding student loan?

Record this information using your payroll software, then register your employee using a Full Payment Submission.

3. Keep detailed records

For at least three years, you must keep a record of:

• Payments made to employees, and any deductions from those payments
• Leave and sickness absences
• Taxable expenses
• Employee benefits

4. Report to HMRC each tax month

The tax month runs from the 6th of one month, to the 5th of the next month. Every time you pay an employee, use your payroll software to:

• Record the date and amount of pay
• Calculate tax and NI deductions
• Calculate the employer’s Ni contribution you’ll pay on their earnings
• Create employee payslips
• Report pay and deductions using a Full Payment Submission

Each month, you’ll then need to pay HMRC any tax and National Insurance owed. Your payroll software will work this out for you.

Do I need to hire a bookkeeper?

If you’re a small business with fewer than 10 employees, you may be able to handle your bookkeeping yourself. Whether or not you hire a bookkeeper is a matter of personal preference. Bookkeeping and accounting services can be expensive, but it may be a worthwhile investment if you’re unlikely to have the time to handle bookkeeping yourself.

Best software for small business bookkeeping

Our full article on Making Tax Digital lists some of the best bookkeeping software for small businesses, complete with pros, cons and price plans. 

The best pay monthly options:

• Xero – starting at £12/month
• QuickBooks – starting at £12/month
• Sage – Starting at £12 + VAT/ month

The best no-subscription options;

• Wave – free, with transaction fees
• Quickfile – free for small businesses

23/03/22: While we want to help as much as we can, the information found here is provided solely for informational purposes and should not be considered financial or legal advice. To the extent permitted by law, Funding Circle does not accept any liability for any loss or damage which may arise directly or indirectly from the use of, or reliance on, the information contained here. If you have any questions, please speak to your professional adviser or seek independent legal advice.