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What financial records do the self-employed need to keep?

When operating on a self-employed basis as a sole trader, you are your own boss, which means that you’re legally responsible for the financial affairs of your business, including the maintenance of financial records, daily bookkeeping and retaining the likes of invoices and receipts. As you keep close watch of your income and expenditure to ensure that the business is running smoothly, there are reporting obligations you are required to meet, writes Mark Halstead of Red Flag Alert.

What financial records do the self-employed need to keep?

If you’re wondering where to start, don’t worry, as we will walk you through your responsibilities and the legal guidelines set out by HMRC. As a sole trader, you must keep your records, particularly relating to your Self-Assessment, for at least 5 years after the 31 January submission deadline of the relevant tax year. You are obligated to retain accounting records which accurately display income and expenditure. You may find that an accountant can relieve the pressure by taking on the responsibility of preparing and submitting your financial paperwork. If you select an accountant offering access to cloud accounting software, you can also submit your records electronically to a portal which can be accessed by your accountant. Here are the records you need to keep if you’re operating as self-employed:

Profit and Loss

If you’re self-employed, it is vital to record your profit and losses, this includes documentation such as receipts, bank statements and invoices. In the unlikely event of an investigation by HMRC, they would require the documentation to evidence your tax liability and whether you are paying the correct amount of tax.

The rules vary if you’re using Traditional Accounting, better known as Accruals Basis, over Cash Basis Accounting.

Cash Basis reporting is when income and expenses are recorded on receiving the money or when a bill has been paid, so income tax will be accounted for only after the money has been received. At the end of the tax year, you won’t have to pay Income Tax on the money you didn’t receive in your accounting period.

You can use Cash Basis if you:

  • Run a small self-employed business, for example, a sole trader or partnership
  • Have a turnover of £150,000 or less a year

Traditional Accounting is when you record income and expenses on the date you issued the invoice or the date you were billed. You will pay tax on any income recorded in the period, whether you have received the funds or not.

If you’re using Traditional Accounting (accruals basis), you will be required to keep a record of the following:

  • Money owed, but not yet received
  • Monetary commitments made, but not yet paid out
  • Stock value and work in progress at the end of the accounting period
  • Year-end bank balances
  • Investments made in the business within the accounting year
  • Total funds withdrawn for personal use

If you are unable to provide records if they’re missing or destroyed, you are not exempt from submitting the information. You must submit either of the following to HMRC:

  • Estimated figures: An approximate value
  • Provisional figures: These are temporary figures whilst you await the actual figures. Once the actual figures become available, you will need to submit these.

Income and expenditure:

This record shows the number of sales and the level of income the business is accustomed to, as required by HMRC.  This record will typically include the following:

VAT

You will be required to retain your VAT records if you are VAT registered, this can be digitally stored if you are using online accounting software. You should keep a record of your sales, purchases and VAT invoices, the latter should be stored for 6 years.

Expenses

You must keep receipts for expenses incurred wholly for business purposes. This allows you to deduct allowable expenses to accurately calculate taxable profit. Please note that your entitlement to expenses may differ depending on your employment status.

Personal Income

Record how much you pay yourself and other forms of personal income.

PAYE

This is only applicable if you employ staff members.

If you are a limited company director, you are required to keep additional records, including the following:

  • Money received and spent by the company
  • Company assets
  • Company debt or debt owed
  • Company stock owned at the end of the financial year
  • Stocktaking used to work out a stock figure
  • Goods bought and sold
  • Customer and supplier details unless you run a retail business

You are required to keep financial records for five years after the submission deadline for the relevant tax year.

As a sole trader, you are the exclusive owner of the business, so you will be held personally liable for debts and legally obliged to pay outstanding creditors if you fall into arrears. Although this operating structure can be a profitable way to run your business, it can also pose a high risk. As a result, it is important to ensure that you keep a close watch of the finances of the business. To accurately do so, your financial records must be up to date and regularly organised to comply with HMRC obligations.

More on small business taxes and limited company taxes.

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