Small business accounting: the essential guide for UK merchants

If you’re starting a business, navigating the complexities of accounting is essential for your long-term success.

From self-assessment tax returns to payroll, learning the basics can boost your confidence when making financial decisions and give you a better idea of your budgets and cash flow forecasts.

It also makes it simpler to comply with government regulations and could even save you money on your small business tax bill.

To help you take control of your small business accounting, we’ve put together everything you need to know in this essential guide for UK merchants.

Learn more about record keeping and the key accounting deadlines for your business diary, as well as how to find a professional accountant vs financial advisor to simplify your small business finances.

Small business accounting: a quick overview

Small business accounting is the process of preparing and presenting your financial data. It involves a number of tasks we’ll look at in this article, including:

• Record keeping.

• Creating financial statements and reports.

• Tax returns.

• Payroll.

Maintaining accurate accounts is essential for compliance and legal standards. It also provides a clear overview of your financial health and profitability, helping you make better decisions to suit your small business budget.

For example, through analysing financial records you can learn more about your working capital. This is the amount of money you need to run day-to-day business operations.

It also makes it easier to create a break-even analysis, which compares the costs of your business with your sales prices to determine when you’ll break even.

What are the differences between accounting and bookkeeping?

Small business accounting services can often be confused with bookkeeping. While there is some overlap between the two, they aren’t the same.

• Bookkeeping for small businesses involves the ongoing tasks of recording your cash flow (the money moving in and out of your business), matching receipts and invoices to transactions, and managing payroll. 

• Accounting presents this information in tax returns and financial statements, summarising your business’ finances.

While accounting relies on bookkeeping tasks, the two serve different purposes. 

Do I need an accountant for my small business?

You don’t need professional help to comply with HMRC and Companies House regulations, but it’s crucial that your accounts are correctly recorded.

Do-it-yourself (DIY) accounting for small businesses is possible if you’re confident in your financial abilities or are willing to learn.

If you’re unsure which option is right for you, let’s take a look at how an experienced accountant can help with small business finances:

• Save time on accounting tasks.

• Ensure compliance.

• Reduce stress around deadlines.

• Avoid fees and legal action due to non-compliance.

• Maximise deductible expenses.

To ensure you benefit from hiring accountants for your small business, choose a registered, qualified professional.

Which accounting style is best for small businesses?

When it comes to how to do accounting for a small business, the two main options are accrual accounting and cash basis accounting, which record income and expenses in slightly different ways.

Cash basis accounting

Cash basis accounting records transactions when cash exchanges hands. This means that revenue is recognised when cash is received, and expenses are recorded when cash is paid out.

For example, you won’t add an invoice to your accounts until after you’ve received the money in your business account.

Accrual accounting

Accrual accounting records revenues and expenses when they’re incurred, regardless of when cash transactions occur. For example, if you send an invoice to a client, the transaction is recorded on the date the invoice is issued rather than when it’s paid.

The best accounting system for a small business depends on your business structure.

For sole traders in the UK earning less than £150,000 a year, cash basis accounting is the most common when submitting your self-assessment tax return.

If you prefer the accrual method, you can switch by selecting this option when filling out your return.

Limited companies and partnerships in the UK aren’t permitted to use cash basis accounting. In these cases, accrual accounting is mandatory with the exception of value-added tax (VAT) where cash basis can be used.

To help you make the right choice for your small business, we’ve taken a look at the pros and cons of each accounting method.

Small business accounting legal requirements

When learning how to do accounting for your small business, there are legal requirements you need to be aware of.

These regulations are designed to make tax compliance simpler, protect your employees and ensure your business data is stored correctly.

Even when working with a small business accountant, understanding legal obligations ensures you know which documents to keep and what information you need to prepare.

To learn more, we’ve outlined key legal requirements for small business accounting.

Tax assessment

Every business needs to submit financial records to HMRC or Companies House.

For sole traders, you’ll submit a self-assessment tax return (SA100) to HMRC. This is a record of your income and expenses, as well as other key tax information including your business address and any interest you receive.

If you own a limited company or partnership, you’ll submit your corporation accounts and a company tax return (CT600) to Companies House.

We’ll look at how different business structures submit their accounts in more detail later in this guide.

If your small business earns £90,000 in any 12-month period, you’ll also need to register for VAT. These are taxes added to your product prices or service prices and paid to the government.

After registering for VAT, you’ll need to:

• Add the correct rate of VAT to all of your products and services.

• Maintain records of VAT purchases.

• Regularly submit a VAT return to HMRC (this is usually every 3 months).

• Pay your VAT to HMRC.

Businesses paying employees must register for Pay As You Earn (PAYE). This is a government scheme that collects Income Tax and National Insurance (NI) from your employees throughout the year.

PAYE is applicable if your employees:

• Earn more than £123 a week.

• Receive company benefits or expenses.

• Have ever received Incapacity Benefit, Employment and Support Allowance, or Jobseeker’s Allowance.

• Have had another job.

Record keeping

Keeping records of your income, expenses, payroll and assets is a legal requirement for all businesses.

Records provide proof of your income and expenses and can simplify your year-end accounts. You may also be asked to present your records to HMRC, such as in the case of an audit.

Your business should have 6 years of financial records, unless you’ve been trading for fewer years. These include:

• All income transactions (such as product sales or invoices for services).

• All business expenses (including proof of purchase receipts or statements).

• VAT records.

• PAYE records.

• Personal income records.

The best accounting software for small businesses will keep records for you. You can also use bank statements and invoices to make record-keeping simpler.

Financial statements

Financial statements are required when submitting accounts to Companies House. These track the activities and financial performance of your business throughout the accounting period.

Financial statements include:

• Profit and loss reports: A full report of your cash flow, including all sales you’ve made, business costs incurred and any profits or losses.

• Balance sheets: An overview of the value of your company on the final day of your financial year (including what you’re owed or owe).

• A director’s report: A statement including the names of directors and the main activities of your business.

• Notes on the accounts: Any additional data or context needed for the accounts provided.

Compliance with Making Tax Digital 

Making Tax Digital (MTD) is a UK regulation that requires VAT-registered businesses to keep digital records of accounts.

All VAT returns must be submitted through MTD small business accounting software, ensuring compliance with government systems.

New VAT-registered businesses will be signed up to MTD automatically through HMRC. You can then connect your small business accounting app or software to your HMRC MTD account.

Data Protection Act

It’s important that small businesses are aware of the UK’s Data Protection Act and General Data Protection Regulation. This outlines strict legal requirements for the storage of personal data.

When it comes to how to do accounting for a small business and comply with data protection, pay attention to payroll data. Any information used to pay your employees should be:

• Stored correctly.

• Protected against unauthorised access using encryption and firewalls.

• Only kept as long as necessary.

Additional practices to ensure data protection in your small business include only collecting and processing the minimum amount of payroll data necessary and conducting regular data audits to ensure you remain legally compliant as a small business.

For example, if you run outdoor events in the summer, the temporary nature of your business makes data destruction particularly important. As well as keeping the information safe using reputable payroll software, you’ll need to destroy payroll data when the season ends to remain compliant.

How to do accounting for your small business

How you present and submit your accounts for small business tax compliance depends on your structure. To learn more, we’ve looked at the requirements for sole traders, limited companies, and partnerships.

Sole traders

A sole trader is a single owner of a business. In this structure, you and your business are a single entity and you’ll pay income tax and NI on your business profits.

When submitting your accounts to HMRC, you’ll fill out a self-assessment (SA100) which covers the UK tax period of 6th April to 5th April the following year.

To prepare for your self-assessment, make sure you have records of your:

• NI number - this helps HMRC identify your records and ensure your contributions are correctly recorded.

• Revenue earned - the money you earned from your business activities throughout the tax year

• Deductible expenses - such as office supplies, travel costs, advertising, and utilities.

• Interest accrued - any interest earned from business-related savings accounts or investments. 

• Government support - details of any grants, benefits, or relief you’ve claimed.

If you’re a VAT-registered sole trader, you’ll also need to submit a VAT return using MTD software every 3 months. VAT payments are usually due on the 7th of the given month, and it’s advisable to submit your payment earlier to ensure it’s received.

Limited Companies

The accounts for limited companies can be more complex than for sole traders. You’ll need to file:

• Annual accounts - a financial statement submitted to Companies House, summarising your company's yearly performance.

• A corporation tax return (CT600) - an annual tax return submitted to HMRC detailing income, expenses, and corporation tax owed.

• A confirmation statement (CS01) - an annual update to Companies House confirming your company’s current details. 

• VAT returns - quarterly or annual submissions to HMRC reporting VAT collected and paid.

• PAYE and payroll submissions (P60s) - regular payroll tax reports submitted to HMRC and end-of-year summaries for your employees.

Your annual accounts and confirmation statement will be filed with Companies House. Your corporation tax, VAT return, PAYE and P60s will be filed with HMRC.

In terms of how to pay yourself as a business owner, you’ll record a salary as part of your expenses filed in your accounts and tax return. This is eligible for personal income tax. You may also take dividends, which are a distribution of a portion of the business profit among shareholders.

Key deadlines for limited companies to be aware of include:

• Submitting your first accounts: 21 months after the date you registered your business with Companies House.

• Submitting your annual accounts: 9 months after your financial year ends.

• Submitting your tax return: 12 months after your financial accounting period ends.

• Paying Corporation Tax: 9 months and 1 day after your financial accounting period ends.

• Submitting your VAT return: Every 3 months.

• Paying your VAT return: 1 month and 7 days after the submission deadline (usually on the 7th of the month).

• Year-end payroll submissions: 19th April after the tax year-end.

Partnerships

Partnership accounting works slightly differently from sole traders and limited companies.

To begin with, you’ll need to select one partner to be responsible for submitting the company accounts. This will be done through a Partnership Tax Return (SA800).

You can choose to present your accounts using either cash basis accounting or accrual accounting. You’ll then need to record your company profits or losses, expenses, and other key information such as any small business grants you receive.

Your partnership tax return will be due on the 31st October following the end of the tax year if you’re filing a paper tax return. Digital tax returns are due by 31st January the following year.

Each individual partner will also need to detail personal income from the business profits. To do this, you’ll submit a standard self-assessment tax return (SA100). This follows the same deadlines as the partnership tax return.

Best practices for small business accounting

Hiring accountants for a small business makes legal compliance simpler, but you can learn how to manage your accounts yourself.

To help you bring professional management to your finances, we’ve put together some best practices to follow.

Separate personal and business finances

Make cash flow management easier by separating your personal and business finances. With a business account, you can:

• Keep a clear digital record of your income and expenses.

• Provide proof of business purchases.

• Download tax-ready statements.

• Quickly see an overview of your financial health.

To separate your personal and small business finances, make sure all of your business transactions go through your business account.

For example, if you sell vegan cheese at a market, your card payments should be directly linked to your business banking. Any cash payments you receive at the market should be deposited into your business account, too, for a cohesive record-keeping system.

Store your invoices and receipts

To maintain records, create a system for storing your receipts, invoices and other financial documents.

There are no rules on how you should store your records, though to avoid documents being lost, such as due to fire or human error, you could create a digital storage system.

You can do this by using accounting software and tools, cloud file storage, or internal file storage. Any physical documents should be scanned and uploaded to your digital file system.

Spreadsheets are also useful for keeping a digital record of your income and expenses.

Let’s say, for example, that you start an online business offering life coaching. When you send an invoice or receive an online payment, you can add the date, amount, and invoice number to your spreadsheet.

You can also link to any useful files like an invoice of the PDF and add notes to make tracking the payment simpler.

Understand deductible expenses

Certain business expenses are tax deductible, meaning that they’re removed from your total revenue to create your business’s gross profit. This lowers your tax bill and saves your business money.

Deductible expenses are usually costs that have to be incurred to run your business.

For example, if you own a local pub, deductible expenses would include the initial costs of your beverages, the costs of ingredients used to make your meals and any rent or mortgage payments for the premises.

As a one-on-one personal trainer, deductible expenses might include travel costs, training equipment costs and your monthly website subscription.

If you’re wondering ‘how much is an accountant for a small business?’, do note that these costs are deductible. This could make the cost of an accountant more suitable for your existing budget.

Monitor your cash flow

Your cash flow directly impacts the health of your business. When carrying out accounting tasks, it’s crucial you monitor the money moving in and out of your business for a number of reasons, including:

• Ensuring you have enough money to cover your expenses.

• Creating accurate budgets and cash flow forecasts based on your current financial health.

• Making informed decisions for your business based on your financial health.

• Staying prepared for shareholder questions and potential partnerships or business opportunities.

• Ensuring you can meet any debt obligations.

• Detecting cash flow problems early to enable quick intervention.

Monitoring cash flow also makes it easier to see when an incoming invoice hasn’t been paid. You can then follow this up with the customer or client, politely making them aware they have an outstanding invoice with your business.

Speak to a professional

Small business accounting is an important task with many legal requirements. To increase your confidence and manage your finances with ease, book a meeting with an accountant.

By speaking with a qualified professional, you can ask questions such as:

• How much do accountants charge for small business tax returns?

• What software do you provide to digitise my accounts?

• How can you help my business specifically?

• Do you offer accounting packages for small businesses?

This will give you a more comprehensive idea of how accountancy services could benefit your small business and whether the cost of an accountant for a small business is an expense that works with your budget.

Disclaimer: The contents of this page are intended for informational purposes only and should not be construed as professional advice. For matters requiring legal or financial expertise, it’s recommended to seek guidance from qualified professionals.