Accounting When You Are Self-Employed: A Guide

Starting your own business as a self-employed individual can be an exciting and empowering experience. However, it comes with its own set of challenges, one of which is managing your finances. Proper accounting is essential to ensure that your business runs smoothly, remains compliant with tax regulations, and remains financially healthy. Whether you’re a freelancer, consultant, tradesperson, or owner of a small business, understanding accounting is vital. In this guide, we’ll cover everything you need to know about accounting as a self-employed person in the UK.

1. Understanding Self-Employment in the UK

Before diving into the accounting specifics, it’s essential to understand what it means to be self-employed. In the UK, you are considered self-employed if you run your own business, bear responsibility for its success or failure, and do not work for a specific employer who pays a regular salary. This includes freelancers, sole traders, and independent contractors.

When you’re self-employed, you are responsible for keeping track of your income, expenses, and taxes. Unlike salaried employees who have their taxes automatically deducted, self-employed individuals must manage these obligations independently.

2. Setting Up Your Accounting System

To successfully manage your finances as a self-employed individual, you need an organised accounting system. Here’s how to get started:

Open a Separate Business Bank Account

While not legally required for sole traders, having a separate business bank account is highly recommended. This will help you clearly distinguish between personal and business finances, making it easier to track income and expenses.

Choose an Accounting Method

There are two main accounting methods you can use:

• Cash Basis Accounting: You record income and expenses when money actually enters or leaves your bank account. This method is simpler and more suitable for self-employed individuals with straightforward financial transactions.
• Accrual Basis Accounting: You record income when it is earned and expenses when they are incurred, regardless of when money changes hands. This method is more accurate for businesses with complex transactions but is more time-consuming.

Use Accounting Software

Investing in good accounting software can save you significant time and effort. Tools like QuickBooks, Xero, FreeAgent, and Sage are popular in the UK for managing invoices, expenses, and tax reporting. These tools often integrate with your bank account and automate much of the record-keeping.

3. Tracking Income and Expenses

Properly tracking your income and expenses is the foundation of good accounting. It allows you to understand your business’s financial health and ensures that you only pay the correct amount of tax.

Recording Income

Keep track of every payment you receive for your services. This includes invoices, receipts, and any other documentation that verifies your income. Make sure to include all types of income, even if it’s from a side gig or a one-off project.

Tracking Expenses

Expenses can include a wide range of costs, such as:

• Office supplies and equipment
• Software subscriptions
• Travel expenses for business-related activities
• Professional services (e.g., legal or accounting fees)
• Marketing and advertising costs
• Utilities, if you work from home (a proportion of rent, electricity, and internet)

Remember to keep all receipts and documentation related to these expenses. This is crucial if HMRC decides to audit your business.

4. Understanding Allowable Business Expenses

As a self-employed individual, you can deduct certain expenses from your income to reduce your tax liability. However, HMRC is strict about what counts as an “allowable” business expense.

Here are some common examples:

• Travel Costs: Costs for business travel, such as fuel, parking, or public transport, can be deducted. However, daily commuting from home to a regular place of work is not deductible.
• Office Costs: If you work from home, you can claim a portion of your household expenses, such as rent, mortgage interest, utilities, and broadband.
• Training and Courses: Costs for training courses directly related to your business can be deducted, as long as they help you maintain or improve skills in your current line of work.
• Marketing and Advertising: Expenses on social media advertising, website hosting, and promotional events are generally deductible.

5. Filing Taxes as a Self-Employed Person

Self-employed individuals in the UK are required to file a Self Assessment tax return annually. The tax year runs from 6 April to 5 April the following year, and your tax return for a given tax year is due by 31 January of the following year.

Registering with HMRC

If you’re new to self-employment, you must register with HMRC by 5 October of your business’s second tax year. You’ll receive a Unique Taxpayer Reference (UTR) number, which you’ll need for filing your tax returns.

Understanding Your Tax Obligations

As a self-employed person, you will need to pay:

• Income Tax: Based on your total earnings after deductions.
• National Insurance Contributions (NICs): Class 2 NICs if your profits are above £12,570 and Class 4 NICs on profits above £9,568 (tax year 2023/24).
• VAT (Value Added Tax): If your annual turnover exceeds £85,000, you must register for VAT.

Payment on Account

Self-employed individuals are often required to make payments on account. This means paying your tax bill in two installments (31 January and 31 July) based on your previous year’s tax liability. Be prepared to budget for these payments to avoid cash flow problems.

6. Managing Cash Flow

One of the biggest challenges for self-employed individuals is managing cash flow. Unlike salaried employees, your income may fluctuate from month to month. Here are some strategies to help:

• Build an Emergency Fund: Having a reserve of at least three to six months’ worth of expenses can protect you during slow periods or unexpected events.
• Invoice Promptly: Ensure that you send invoices as soon as the work is completed and set clear payment terms, such as “Net 30 days.” Consider using accounting software to automate this process and send reminders to clients.
• Monitor Receivables: Stay on top of outstanding invoices and follow up with clients who haven’t paid on time. Cash flow issues often arise when payments are delayed.

7. Tax Reliefs and Incentives

The UK government offers several tax reliefs and incentives that self-employed individuals can take advantage of:

• Annual Investment Allowance (AIA): The AIA allows you to deduct the cost of certain business assets, such as equipment and machinery, up to a specific limit (£1 million as of 2023/24).
• Research and Development (R&D) Tax Relief: If your business is involved in research and innovation, you may be eligible for R&D tax relief, which can significantly reduce your tax bill.
• Seed Enterprise Investment Scheme (SEIS): If you’re looking to grow your business, the SEIS offers tax relief to investors who purchase shares in your company. This can be a great way to attract investment.

8. Common Accounting Mistakes to Avoid

Even with the best intentions, it’s easy to make mistakes when handling your finances. Here are some common pitfalls:

• Mixing Personal and Business Finances: Keep your accounts separate to avoid confusion and ensure accurate reporting.
• Failing to Keep Receipts: Always keep records of expenses, even for small purchases. This will help during tax filing and if HMRC audits your business.
• Missing Tax Deadlines: Missing the Self Assessment deadline can result in penalties. Mark important dates in your calendar to avoid this.
• Underestimating Tax Bills: It’s wise to set aside around 20-30% of your income for taxes to avoid surprises.

9. Hiring an Accountant or Bookkeeper

While many self-employed individuals handle their own accounting, hiring an accountant can be beneficial, especially if your finances are complex. An accountant can help with tax planning, ensure compliance, and provide financial advice. This can save you time and potentially reduce your tax liability.

Conclusion: Stay Organised and Informed

Accounting as a self-employed person may seem daunting at first, but with a bit of organisation and the right tools, it can become a manageable part of your business. By keeping thorough records, planning for taxes, and staying on top of your cash flow, you’ll set yourself up for financial stability and long-term success.

Embrace the learning process and remember that good financial management is crucial for the growth and sustainability of your business. With the right approach, you’ll be well on your way to thriving in your self-employment journey.