Bookkeeping for Small Businesses & Sole Traders

Bookkeeping for Small Businesses & Sole Traders


Bookkeeping plays a vital role in running your own business, especially when it comes to declaring any profit or loss in your annual tax return, and offsetting allowable expenses against your taxable income.

The following guide for small business owners and sole traders looks at the importance of good bookkeeping and provides essential best practice advice.

What is bookkeeping?

If you are either a sole trader or limited company, you must keep certain financial records. Bookkeeping is the first important step in ensuring that your business meets its accounting and statutory filing responsibilities with HMRC.

As a limited company, bookkeeping will also allow you to fulfil your responsibilities to report your financial performance to shareholders and Companies House as required by law.

Bookkeeping means you must keep an accurate record of any money coming in and out of your business, including copies of any sales invoices, bank statements or other evidence in support of these figures.

You must also keep a detailed record of any costs incurred in running your business during the course of the tax or financial year, plus any receipts.

If you are VAT-registered, in addition to keeping records of your income and outgoings for your business, you will need to keep separate records of your sales and purchases, together with VAT invoices. You must also keep a separate summary of your VAT, known as a VAT account, recording the value added tax that you charge and pay out.

Why is bookkeeping important?

There is no set format for bookkeeping. You can use a variety of manual or digital methods, or both, to record and backup their financial records. These can range from paper filing systems to using simple online bookkeeping or complete accounting software. If you are a new business owner, you may not yet have a system in place. Still, the importance of good bookkeeping cannot be underestimated.

Keeping track of the income and outgoings related to your business is essential when completing your annual tax or quarterly VAT return. In this way, the level of income tax and NI contributions you are required to pay as a sole trader, partner or company director, or corporation tax as a private limited company, together with any VAT, can be assessed.

Bookkeeping is also an important part of tracking turnover and monitoring cashflow for your business, including amounts owed by customers or the business itself. By regularly balancing your books, this can help you to budget for any upcoming payments and prepare for the financial year ahead, including setting aside enough money to meet your tax liabilities. Even with the help of an accountant to complete your tax return, you will need to keep your records and documents sufficiently organised to enable them to do their job.

When your bookkeeping is both well-organised and up-to-date, this can allow you, or your accountant, to assess the financial health of your business. This can help you to decide how much to pay yourself by way of a self-employed salary or dividends, how to become more tax efficient, what business structure is right for you and whether you should register for VAT.

If you are looking to expand your business, good bookkeeping can also help you to prove its existing and potential future profitability to investors, new partners or financial lenders.

What is the difference between bookkeeping and accounting?

The terms bookkeeping and accounting are sometimes used interchangeably, but this is not technically correct.

Bookkeeping involves the keeping of up-to-date records relating to the running of your business, including any profit and loss, and all business-related expenses. This is focused on the systematic recording and organising of financial data, from income generated through the sale of goods or services, to everything your business spends money on.

In contrast, accounting is about the interpretation and presentation of that data to enable you to report on the financial position of your business as required by law, for example, to HMRC or Companies House. The analysis of financial data used in accounting can also help you to make informed decisions about your business, such as helping it to grow or making cutbacks.

So while bookkeeping refers specifically to the tasks involved in recording the financial activities, accounting is the overall practice of managing the finances of a business.

What is bank reconciliation?

Bank reconciliation is a process performed by a business to ensure that its records are correct and verified. This is done by comparing the recorded income and outgoings for the business with the amounts shown on its bank statements. Only once any differences or discrepancies have been explained, can your bank statements be said to be reconciled.

To reconcile your bank statements, you will need to get a list of your bank and any business credit card transactions and match them against your recorded sales invoices and expenses. This can be done using paper statements, from online banking or by having the data sent straight to your accounting software. You will then need to open your ledger of income and outgoings, for example, in a logbook, on a spreadsheet or in any software package.

With both sets of information to hand, you will need to find your starting point. This is the last time the balance on your business books was the same as the balance in your bank or credit card accounts. Ideally, you should look to reconcile your bank and credit card statements at the end of each month, if not weekly. You will then need to match any income against the corresponding deposits, and expenses against your withdrawals.

If there are any mystery transactions you should investigate the reason for this, where bank reconciliation can help to highlight potential problems, such as bounced or unauthorised payments, providing you with better controls over incoming and outgoing payments. Having matched and accounted for everything, your business bank balance should match the totals in your accounting records. This will then be the starting point for your next reconciliation.

Bookkeeping best practices

Best practice when it comes to bookkeeping can be varied, especially as business owners are permitted to use a variety of different methods, from manual to online systems. Still, the key to good bookkeeping is that your records must be accurate, complete and readable, and supported by paper or digital copies of any invoices, bank statements and receipts, etc.

However, with the introduction of a new government scheme (Making Tax Digital) to transform the tax system and move it fully online, you should be looking at ways in which you can comply with these digital requirements going forward. This should include registering with HMRC for online self assessment, and utilising modern accounting and bookkeeping software to improve the management of your business finances.

One of the advantages when it comes to online software is typically how easy it is to enter and access information about how your business is performing. Online software can also be used to simplify the process of bank reconciliation, enabling you to directly import your banking transaction data, and showing matches or highlighting discrepancies with the help of data capture tools, to ensure that everything has been accounted for.

Using accountancy and bookkeeping software will still require regular input from you to keep it up-to-date. You may also need the help of an accountant or tax advisor to interpret the data, make well-informed financial decisions, and comply with your financial reporting and statutory filing obligations. However, going ‘online’ will soon be unavoidable.

For VAT-registered businesses, rules are already in place for online VAT reporting. Under these rules, most VAT-registered business with a taxable turnover above the £85,000 VAT threshold must now use digital methods to store their VAT information and submit their quarterly returns to HMRC.

This will require the use of compatible software packages, or other software like spreadsheets, that connect to HMRC systems. If you use different software packages to keep records and submit returns, you will need to link them. From 1 April 2022 all VAT registered businesses must register under the Making Tax Digital for VAT rules, regardless of earnings. As Making Tax Digital is further rolled out, you will need to arrange all your tax accounting online.

Bookkeeping pitfalls to avoid

There are various common pitfalls when it comes to bookkeeping that should be avoided:

Leaving it to the last minute

Good bookkeeping only requires a few minutes each day or a designated time slot each week to keep your records up-to-date. By failing to make regular updates, this can easily have a knock-on effect on your ability to meet your financial reporting and statutory filing obligations. In turn, this could result in financial penalties.

Combining your business and personal accounts

Good bookkeeping means ensuring that your business finances are kept entirely separate from your personal finances. By combining the two together, where you choose not to have a separate business account, can lead to confusion, time-consuming accounting and even costly mistakes, especially when it comes to deciding which expenses were ‘wholly and exclusively’ for business purposes.

Taking or making cash payments

Good bookkeeping means being able to provide accurate records of your income and outgoings, and providing evidence in support of these. By taking or making cash payments, rather than using a debit or credit card for transactions so that they are recorded, you could easily lose track of money coming in and out of your business, especially as paper receipts can be easily misplaced, damaged or destroyed.

Failing to keep receipts

Good bookkeeping not only requires you to keep accurate and up-to-date records, but also to retain any receipts, or copies of these, in support of your outgoings. By failing to keep receipts, or by relying solely on paper copies without any digitally scanned backups, can leave you exposed to penalties if HMRC chooses to investigate any business expenses declared on your annual tax return.

Failing to assess your tax liabilities

Good bookkeeping will allow you to sensibly assess in advance what payments you will need to make to HMRC so that you can manage your business finances accordingly. By failing to keep on top of your bookkeeping, such that a suitable percentage of your trading profits is not put aside each month, this can leave you facing financial penalties and interest for late payment of tax. This is often compounded by the fact that if you leave filing your return until the eleventh hour, you will not know how much tax you are liable to pay until the same date that payment falls due.

Good bookkeeping can be key to running a successful and profitable business

One in which you know what money is coming in and going out at all times; where you can maximise the amount of business expenses to be offset against any taxable income; and not leave yourself exposed to financial penalties for any failure to meet statutory deadlines.

However, seeking expert advice at an early stage can be hugely beneficial in ensuring you are compliant and maximising the businesses’ financial affairs.

Bookkeeping FAQs

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Legal disclaimer

The matters contained in this article are intended to be for general information purposes only. This article does not constitute legal or financial advice, nor is it a complete or authoritative statement of the law or tax rules and should not be treated as such.

Whilst every effort is made to ensure that the information is correct, no warranty, express or implied, is given as to its accuracy and no liability is accepted for any error or omission.

Before acting on any of the information contained herein, expert professional advice should be sought.


Bookkeeping for Small Businesses & Sole Traders 1
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Gill Laing is a qualified Legal Researcher & Analyst with niche specialisms in Law, Tax, Human Resources, Immigration & Employment Law.

Gill is a Multiple Business Owner and the Managing Director of Prof Services Limited - a Marketing & Content Agency for the Professional Services Sector.

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