Accounting and Bookkeeping: A Guide for Sole Traders

Embarking on the journey of working for yourself as a sole trader? If you are, it’s important to know that managing your accounts and bookkeeping is essential. 

From recording income and expenses to understanding tax obligations, keeping track of your finances means you stay on the right side of tax regulation. Equally important, it gives you less hassle and more peace of mind. 

If it all seems a bit intimidating, don’t worry: we've got you covered. Say goodbye to accounting headaches and let us simplify the process for you. Here are the essential steps to get your sole trader accounts set up and running smoothly.

Step 1: Register as a sole trader with HMRC

To begin your journey as a sole trader, the first step you’ll need to take is to register with HM Revenue and Customs (HMRC). You might be wondering how to go about this process. 

Fortunately, we've got you covered with our comprehensive step-by-step guide on registering as self-employed.

Remember, you need to keep HMRC informed of every change in your tax status, whether you’re starting, stopping or altering any part of your self-employment. This means that they will be kept aware of when and if to expect your tax returns. 

Step 2: Setting up your sole trader bank account

While it's not a legal requirement for a sole trader to have a separate business bank account, there are significant advantages to keeping your business and personal finances separate. 

This is because operating with only a personal bank account will mean you’ll need to meticulously differentiate between personal and business expenses, adding complexity and consuming more of your time.

By having a dedicated business bank account, you can easily track and record your business-related expenses and income. This simplifies the process of completing your annual accounts and Self Assessment Tax Return, saving you valuable time and effort.

Step 3: Keep track of income and expenses

Now your bank account is set up, the next step is to record your income and expenses. Accurate record-keeping is crucial for managing your sole trader accounts effectively. To maintain a clear overview of your business finances, it's essential to record your income and expenses systematically.

For income, create a system to track and document all sources of revenue, including sales, services rendered, or any other sources of income related to your business activities. Be diligent in recording the amounts, dates, and details of each transaction.

Similarly, meticulously track your business expenses. This includes purchases, bills, and any other costs incurred for your business operations. Keep receipts and invoices organised, categorise expenses appropriately, and note down the purpose of each expense.

Spreadsheets can be a practical solution for this if you prefer a hands-on approach and want the flexibility to create your own invoices. However, it is worth noting that spreadsheets may have limitations in terms of functionality and reporting capabilities.

Alternatively, many business owners choose to use commercial bookkeeping software. These tools offer a range of features such as expense and income tracking, invoice creation, and automatic bank account feeds. 

Online accounting systems are increasingly popular among small businesses due to their convenience and added functionalities. These systems eliminate duplication and offer features which will save you time and money.

By maintaining detailed records of your income and expenses, you'll have a solid foundation for accurate financial reporting, tax calculations, and business analysis. This step ensures you have a comprehensive picture of your financial performance as a sole trader.

Step 4: Managing tax obligations

As well as your income and expenses, it's crucial as a sole trader to understand your tax obligations and set aside the necessary funds each year. This is essential for completing your Self Assessment, which determines the amount of tax you owe.

So, familiarise yourself with the income tax thresholds and National Insurance Contributions (NICs) applicable to your earnings. Each tax year has a Personal Allowance, currently set at £12,570 (2023/24), which allows you to earn income tax-free. 

Income above this threshold is subject to varying tax rates:

Basic Income Tax rate (20%): Applies to income from £12,571 up to £50,270.

Higher Income Tax rate (40%): Applies to income between £50,271 and £125,140.

Additional Income Tax rate (45%): Applies to income over £125,140.

Sole traders are also responsible for paying Class 2 and Class 4 NICs. 

Class 2 NICs, at a rate of £3.45 per week (2023/24), are payable directly to HMRC if your profits exceed £6,725 per year. 

Class 4 NICs, at varying rates (9% on profits between £12,570 and £50,270, and 2% on profits over £50,270), are paid through Self Assessment.

Remember to consult HMRC resources for detailed information on tax and National Insurance for the self-employed to ensure compliance with the latest regulations.

Step 6: Completing a Self Assessment

As a sole trader, it is essential to complete an annual Self Assessment Tax Return and submit it to HM Revenue and Customs (HMRC). This process provides HMRC with accurate information about your income and expenses, ensuring you are taxed correctly.

When you register as a sole trader with HMRC, you will be automatically enrolled to complete the Self Assessment Tax Return each year. It's important to register on time to avoid penalties.

For self-employed individuals filing self-assessment tax returns, here are the key filing deadlines:

• 31 October: Paper Filing Deadline

If you choose to file a paper tax return, it must be submitted by this date.

Late filing penalties may apply even if you have no tax to pay.

• 30 December: Online Filing Deadline for PAYE Tax Collection

If you have employment or pension income and want HMRC to collect the self-employed tax through your PAYE tax code, you need to submit your tax return online by this date.

This option is available if you owe less than £3,000 and may apply for income over £30,000.

• 31 January: Online Filing Deadline and Balancing Payment Due

All tax returns filed online must be submitted by this date.

Again, late filing penalties apply if you miss this deadline, even if you have no tax to pay.

Your balancing payment of tax for the previous tax year is due at this time.

You may also have a payment on account for the following tax year due on this date.

• 31 January + 1 year: Deadline for Amendments

If you discover an error on your paper or online tax return, you can amend it up to 12 months after the 31 January deadline following the end of the tax year.

Learn more about how to fill out a Self Assessment for the first time with our handy one-stop guide. 

Completing the Self Assessment is a vital responsibility for sole traders, and by following these guidelines and seeking professional assistance if needed, you can navigate this process successfully and fulfil your tax obligations.

Step 7: Payments on account

Once your Self Assessment has been completed, it’s time to think about Payments on Account. Essentially, these are advance payments of Income Tax and Class 4 National Insurance Contributions (NICs) that certain individuals are required to make for future tax years. 

Here are the key details to understand:

If your total Income Tax and Class 4 NICs amount to more than £1,000 or if you do not have tax deducted at source (tax on income before you receive it) on over 80% of your income, you will need to make payments on account.

These payments are due on two specific dates: 31st January and 31st July. By these deadlines, you are expected to make the necessary payments based on an estimate of your tax liability for the upcoming tax year.

Individuals who don't need to do a Payment on Account need to make the full payment of Income Tax and National Insurance by the self-assessment tax return deadline (31 January following the end of the tax year).

Furthermore, because the two Payments on Account are based on an estimated liability, there's a third payment required, which is called a balancing payment. This needs to be made by the self-assessment tax return deadline (31 January following the end of the tax year).

For example, if the payments on account for the tax year (that ended on 5 April 2023) are due for payment on 31 January and 31 July 2023, this balancing payment would be payable on 31 January 2024. This makes sure you have paid the remaining account that is owed to HMRC.

It’s important to note that if the two payments on Accounts don't match the final tax liability, any overpayments can be repaid or set against future tax liabilities.

To ensure compliance and avoid penalties, it's crucial to accurately estimate your tax liability and make timely payments on account by the designated deadlines.

Step 8: VAT registration 

Value Added Tax (VAT) is an important consideration for sole traders, and understanding when and why to register for VAT is crucial. Here's what you need to know:

You are required to register for VAT if any of the following conditions apply to your business:

• Your turnover exceeds £85,000 in a 12-month period.

• You receive goods in the UK from the European Union (EU) with a value exceeding £85,000.

• You anticipate surpassing the VAT threshold within a single 30-day period.

However, there are situations where registering for VAT can be advantageous, even if your turnover is below the threshold. For instance, being VAT registered can enhance your company's perceived size and credibility. Displaying a VAT registration number on your website can give the impression of a larger business.

Additionally, VAT registration allows you to reclaim VAT paid on business purchases, which can be financially beneficial. It's important to keep all relevant VAT information and records for a minimum of 6 years if you are registered for VAT.

Easy and intuitive bookkeeping software for sole traders

Ensuring and maintaining accurate bookkeeping for sole traders has never been easier than Quickbooks. Our accessible and versatile accounting software for sole traders has been used by millions around the world to boost tax compliance. 

With a range of features, from expense tracking, to direct bank connections, to intuitive payroll controls, it will leave you in complete control over your finances. QuickBooks is also fully Making Tax Digital-ready, allowing you to prepare your VAT returns in line with HMRC compliance. What’s more, it couldn’t be easier to set up; learn how you can do that here.

The information on this website is provided free of charge and is intended to be helpful to a wide range of businesses. Because of its general nature the information cannot be taken as comprehensive and they do not constitute and should never be used as a substitute for legal, accounting, tax or professional advice. We cannot guarantee that the information applies to the individual circumstances of your business. Despite our best efforts it is possible that some information may be out of date. Any reliance you place on information found on this site or linked to on other websites will be at your own risk.