What is it?
If you run your own business, you may have a very good idea in your head of how much
you have made this month or this year, who owes you what and what you owe. But then
again, after a while it can become a bit blurred – have I invoiced for that job?, has so and
so paid me? Etc. etc. After a while you realise that you need proper records and that is
exactly what accounting provides.

Accountancy for the sole trader essentially aims to provide two vital pieces of information
– how profitable is your business (the profit and loss account), and what is it worth (the
balance sheet). Within those two statements, a myriad of further information is provided,
such as your bank balances, what you owe your creditors and what your debtors owe
you, but the primary information is the most important – are you making a profit, and
what is your business worth right now?

Why do it?
Most sole traders believe that the only point of producing accounts is to satisfy HMRC by
producing figures to calculate their tax liability. HMRC are certainly one stakeholder with
an interest in your financial affairs, but there are many others, namely yourself (you get
to learn how your business is doing), your bank (if it is going to lend you money, it needs
to know the financial health of your business), your creditors, and any potential investors
in the business.

One little known fact is that actually the profit and loss account that is produced as part
of your financial accounts is not what HMRC use to calculate your tax liability – that is
because certain expenses are not tax deductible, and there are others that HMRC allow
as a tax deduction which may not have been used in the original calculation. For
example, you may have spent a small fortune entertaining new clients, and these
expenses will show up on your profit and loss account – but hell will freeze over before
HMRC allow them as a tax deduction, therefore they get added back in to the profit
figure for the tax accounts. There usually should not be too much of a discrepancy in the
figure from accounting profit and the taxable profit, but they are rarely the same…

How to do it?
You start with a book-keeping system – that is, a methodology of transferring all your
paper invoices and receipts into a regular journal of income and expenditure. This can
be done by a simple paper cashbook, an excel spreadsheet, or a proprietary bookkeeping
system – it depends on what you’re comfortable with, what your business
requires, and what you are willing to spend. Essentially the final accounts are produced
from totting up the totals of each column from your cashbook or spreadsheet.
However, there are two recognised methodologies for recording book-keeping entries –
they are the accruals method, or the cash method. The cash method is most easily
understood – you only make the entry in the journal when the cash is received or paid
out. Under the accruals method however, invoices are recorded when issued, not when
cash is received, and likewise bills are recorded when received, not when paid.

Even HMRC accept both methodologies, although there are certain disadvantages to the cash
method, as you may be limited in claiming for interest on loans or for losses, so
accountants tend to always use (and recommend) the accruals method.

Making Tax Digital
It should be noted at this point that HMRC are making wholesale changes to the way
that submissions are made to them going forward, and this may put paid to the pen and
paper or excel methods of book-keeping outlined above. This is because not only will
HMRC require quarterly reporting of your accounts, they will also require them to be
submitted in a digital format that may require an app or cloud based book-keeping
system. Such reporting is due to begin in April 2019, but could be delayed further (it was
originally intended to begin in April 2018).

Summary
Sole traders and small businesses need to produce annual (or more frequent) accounts
not only for HMRC, but also for their own information and other stakeholders in their
business. This can be done by themselves, or with outside help (such as a book-keeper
or accountant) but it appears that the days of simple spreadsheet accounting are
disappearing, to be replaced by cloud and app accounting, so anyone setting up a new
business now should seek advice in this area before they start.