Small Business Accounting Explained

Simply put, accounting allows you to optimise your entire business. Small business accounting explained below

Introduction – Small Business Accounting Explained

Are you stuck managing the accounts for your business? We’re here to explain the process of business accounting, why it’s important and how to stay on top of your finances so that they are the last thing you are stressed about for your business.

What is small business accounting? 

Accounting is the process of recording, identifying, measuring and interpreting your finances, and doing this for your business will allow you to keep track of your profit and loss, what products and services your business profits off of the most and what areas you could improve on. Keeping track of your accounts will also ensure that you catch a possible dip in profit early on and manage the value of your assets, liabilities and equity. It is also vital to commit to your legal duty of ensuring your accounts reflect this information accurately.

Let’s look at what accounting can help you with.

Budgeting and planning

Align your spending with your goals and forecasted earnings; and remember to take responsibility for your money – such as your legal obligations. 

Assess vital vs optional resources for your business according to what your cash flow allows, for example: wants vs needs.

Having well thought out budgeting and planning proves to be beneficial when seeking investment for your small business; investors want to see the whole picture, such as your spending needs and forecasted spending objective beforehand.


For a healthy, long-term business, you need to be a pro at well-informed decision-making. Spending your money in the right places, identifying which areas of your business are performing better than others, where you need to adjust prices or change suppliers to bring in more business and cutting unnecessary costs can be difficult decisions, but keeping on top of decision-making and conducting little changes to your business along the way will prevent any future financial scares in the future.

Business performance 

Meeting your financial goals is an important part of any business, and analysing your Key Performance Indicators (KPI’s) can help you determine if you are reaching them. Analysing your KPI’s allows you to see what areas your company can improve on and where your business is thriving, allowing you to optimise your short- and long-term growth strategies, ensuring an ever-fruitful business.

Let’s explore the 7 steps to setting up your business account – Small Business Accounting Explained

1. Open a separate business current account 

Companies registered as Limited are legally required to create a seperate business account, however if you are a sole trader, this is optional. We recommend that all companies create a separate business account to save any future stresses at the end of the year. To get your business account there are 2 simple steps:

  1. Choose which account you’d like to make your business account 

    1. Consider transaction and withdrawal fees, introductory offers, customer support and admin features.

  2. Set up a savings account 

    1. Setting aside money each month creates financial security for paying for your yearly taxes if you are self-employed, and will help you organise funds.

2. Consider working with an accountant 

From creating new products and services to analysing your company’s performance and much more, there are a lot of responsibilities entrepreneurs have, but taking time to manage your accounts accurately needs as much time as the other elements of your business. That’s why it can be incredibly helpful to have an experienced accountant helping you keep track of your finances and ensure you have accurate records, make tax season much easier, and keep your books in order.

We know accounting can be an intimidating feat for those of us who are not as experienced as others, which is where accounting and bookkeeping experts can help you stay on track, but how do you determine who the right person is for your business? Well, we recommend looking at your business’s needs, the accountants fee structure, and obtaining an engagement letter.

3. Keep track of your expenses 

To avoid cash flow issues, staying on top of your expenses and outgoings should be your number one priority, especially at the early stages of your business. Expenses are your costs of doing business – the money you’re spending to generate revenue – and can range from employee salaries to materials needed for your business’s services. These expenses can be deducted from your income before it is subjected to taxation, which an accountant can help you keep track of and determine which expenses are eligible for doing so. This will greatly assist you in understanding what areas you are spending money on and determine if it is helping your company or whether this money can be saved.

What can you claim as business expenses? 

  • Labour

    • Full-time employees

    • Independent contractors

    • Freelancers

    • Consultants

  • Rent, utilities, phone and supplies 

    • Office expenses

    • A percentage of your bills if you work from home

  • Business travel 

    • Business trip to meet new clients or service providers

  • Transportation 

    • Track all modes of business transportation.

  • Benefits, education and training 

    • Health insurance

    • Further your employees’ education

    • Allow your employees to learn new skills

  • Entertainment – not redeemable for sole traders 

    • Staff holiday party

  • Food 

    • Business lunches with clients

    • Employee lunches whilst travelling for business

What can’t be claimed as business expenses? 

  • Fines and penalties 

  • Political contributions 

  • Hobby-related expenses 

    • Social or fitness clubs

How can you keep track of your expenses?

Get into the healthy habit of organising receipts and records as soon as possible. It can be useful to track these expenses via a digital spreadsheet or an automated system such as Xero or QuickBooks. Monitoring your employees expenses is also vital, such as reimbursing out-of-pocket expenses and tracking their spending patterns, and creating an expense policy is a great place to start.

  1. Create a clear company expense policy 

    1. Puts everyone on the same page.

  2. Manage employee expenses 

    1. Ensure processes run smoothly.

  3. Adopt modern expense solutions 

    1. To streamline your operations.

How should you organise your expenses? 

Let’s determine which small business accounting method you should use for your company.

  1. Cash method 

    1. Revenues and expenses are recognised at the time they reflect in one’s bank account or are paid.

    2. Suitable for small businesses with a £150,00 turnover or less. 

    3. Optimal for working out your income and expenses for your self assessment tax return for sole traders and partners.

  2. Accrual method 

    1. Revenues and expenses are recognised when the transaction occurs, not when the money reflects in a bank account, requiring tracking receivables and payables.

4. Set up an invoicing system 

An invoice is a document sent to a purchaser from the service provider verifying what the purchaser has or still needs to pay for. Having a good invoicing system is very important; the more efficient the system, the better the cash flow.

Automate your invoicing 

Online invoicing allows you to easily invoice customers who can pay online. Setting up recurring payments is a good idea if you are working on long-term projects or have subscription-based services.

What to include on an invoice:

  • Identification number

  • Date of the invoice

  • Supply date – when the products and/or services were delivered

  • Client’s details

    • Name

    • Email address

    • Home/work address

  • Your details

    • Your name/company name

    • Contact details

    • Business address

  • Description of products and/or services

    • Cost of each item

  • VAT is applicable

  • Total amount owed

  • Your preferred payment method

  • BACS or account details at the bottom of the invoice (optional)

Establish payment terms 

Your payment terms determine when and how you’ll get paid. Have a clear understanding with your clients to ensure they fully expect your invoices and rates.

Prepare for late payments 

You are bound to encounter a few customers who have a habit of paying for their invoices late, which can be difficult for those small businesses relying on each payment. However, you can implement late penalty fees and extend a customer’s payment deadline to make it easier on their cash flow.

Payment terms 

There are a variety of payment terms, we recommend choosing one that best suits your business model.

  • Due on receipt (DOR)

    • Ensures timely invoices as the money will instantly come into your account.

  • Payment in advance (PID)

    • This requires payments to be made ahead of time.

  • End of month (EOD)

    • The payer has a certain number of days to pay for your product or service.

  • Cash on delivery (COD)

    • Payment will be made on delivery.

5. Set up a bookkeeping system

There is a difference between accounting and bookkeeping: bookkeeping is the process of recording and organising your business’s financial interactions; accounting is the act of categorising and analysing this information and summarising your transactions.

How to track your company’s records 

There are many free alternatives to tracking your company’s finances, including these free bookkeeping platforms:

  • Xero

  • QuickBooks

  • Sage 

These programmes automate a number of bookkeeping tasks for you.

6. Calculate your business tax

There are a variety of taxes to be paid depending on your business model.

How to calculate tax as a sole trader 

Pay tax from HMRC’s Self Assessment tax return.

  • Determine if your income is taxable or not

  • Check the deductible allowances from your taxable income or final tax bill

  • Work out the rate your income is taxed

  • Analyse what can be deducted from your tax bill

How to calculate tax as a Limited Company

Pay Corporation Tax through HMRC’s Company Tax Return.

  • Start paying tax as soon as your business starts making a profit

    • Not applicable if you have made a previous loss.

As this process can be quite difficult, time consuming and daunting, it can be beneficial to seek out an accountant if you haven’t already done so to help you along the way. Remember to have an understanding of how everything works yourself as an extra benefit.

7. Check if you need to register for VAT

All businesses must register for Value Added Tax (VAT) if your annual turnover is £85,000 or more. For companies below this threshold, registration is optional. This means that you will charge customers at the 20% rate of VAT, adding 20% to your invoices and keeping that amount aside from what your customers pay you.

due VAT = output VAT – input VAT 

VAT is then reclaimable on any business-related purchases and expenses. Businesses must also pay the net amount of the two over to HMRC and is due on a quarterly basis.

8. Cash flow management 

Cash flow is the money flowing in and out of your business, and keeping track of it is vital in determining your company’s financial health. The more cash your company is bringing in, the healthier it is. If your company is struggling, however, remember to always evaluate the parts of your business that are the most profitable vs those that are not and act accordingly to ensure you are always making a profit.

Cash flow planning is the best way to stay on top of the money moving through your business, and because it is an ever-moving part of your company, it is beneficial to make use of an automated tool that learns from your data and generates cash flow forecasts in minutes.

Conclusion – Small Business Accounting Explained

Small business accounting is often seen as a highly daunting feat, but it doesn’t have to be. With the help of an accountant, planning and staying on top of your books, finances will soon become the easiest part of your business.

Want free advice from a Growth Consultant who will spend time running through aspects of your business and its growth challenges? Learn more here