Setting up Your Business – Part 2

Last week’s Setting Up Your Business – Part 1, reviewed two potential options for your new set ups business structure. After assessing if Sole Trader and/or Partnership is right for you, if you feel that you are ready for something larger, a Limited Company might be right for you, this weeks installment will run through the basics to help you make the right choice for you.

A Limited Company is an entity in its own right and is responsible for everything that it does. Its finances are kept separate to your own personal finances.

A Limited Company is operated by Directors who are responsible for running the Company in the best interests of the shareholders. The Directors may also be shareholders.

As a director of a limited company, you must:

  • try to make the company a success, using your skills, experience and judgment
  • follow the company’s rules, shown in its articles of association
  • make decisions for the benefit of the company, not yourself
  • tell other shareholders if you might personally benefit from a transaction the company makes
  • keep company records and report changes to Companies House and H.M. Revenue and Customs (HMRC)
  • make sure the company’s accounts are a ‘true and fair view’ of the business’ finances
  • file your accounts with Companies House and your Company Tax Return with HMRC
  • pay Corporation Tax
  • register for Self-Assessmentand send a personal Self-Assessment tax return every year – unless it’s a non-profit organisation (eg a charity) and you didn’t get any pay or benefits, like a company car

You can hire other people to manage some of these things day-to-day such as a Certified or Chartered Accountant, but you’re still legally responsible for your company’s records, accounts and performance. You may be personally liable for your company’s business liabilities and be fined, prosecuted or disqualified as a company director if you do not follow the rules.

There are three ways in which you can draw money from a Limited Company:

Salary, expenses and benefits

The Limited Company can register as an employer and you can then draw a Salary from the Company. You will pay Income tax and National Insurance in the same way as any other employee however, as a Director you can defer your National Insurance Contribution deductions until your actual salary reaches the annual threshold. The Company will also pay employers contributions to HMRC with respect to your salary.

Reasonable expenses incurred wholly and exclusively in the course of the running of the business can also be claimed from the Company.

If you or an employee of the Company uses items owned by the Company personally then this must be reported as a benefit received and may also be subject to income tax. There are also some benefits that are ‘tax free’ for the employee however each one is subject to specific rules:

  • Workplace car parking
  • Pension contributions
  • One mobile phone
  • Staff parties (costing up to £150 per head)
  • Qualifying child care (basic rate tax relief only)
  • Relocation costs
  • Relevant training
  • Bicycles
  • Long-service awards
  • In-house gyms and sports facilities
  • Cheap/free canteen meals
  • Gifts unconnected with work (e.g. wedding gifts)
  • Electric cars
  • Business mileage payments
  • Work and safety clothes
  • Overnight expenses if away on business

In addition to the tax free benefits, further savings can be made. With many benefits-in-kind, the employee has to pay Income Tax at the usual rates and the employer has to pay National Insurance at but there is no employee’s National Insurance. Most benefits-in-kind will therefore provide a saving with respect to employee’s National Insurance. For a basic rate tax payer this is an attractive prospect. These types of benefits would include things such as paying for an employee’s gym membership.

Dividends

If your Company makes a profit, then the shareholders can be paid Dividends. The first £5,000 of dividend income in each tax year will be tax-free. Sums above that will be taxed at 7.5 per cent for basic-rate taxpayers, 32.5 per cent for higher-rate taxpayers and 38.1 per cent for additional-rate taxpayers. The new tax came into effect on April 6, 2016. No tax will be deducted at source and taxpayers must use self-assessment to pay any tax due.

Directors Loans

If you draw more money from the Company that you have put into it then this would be classified as a Directors Loan. If your company makes directors’ loans, you must keep records of them. You may have to pay tax on director’s loans. Your company may also have to pay tax if you’re a shareholder (sometimes called a ‘participator’) as well as a director. Your personal and company tax responsibilities depend on how the loan is settled. You also need to check if you have extra tax responsibilities if:

  • the loan was more than £10,000 (£5,000 in 2013-14)
  • you paid your company interest on the loan below the official rate

After reading this two part summary of the potential business structures available to you, you will note that there are pros and cons each structure and what may be right for one start up may not be fit for another. Discussing your options with an Accountant will help you to make the best decision for you. You can view our Choosing Your Accountant article from the beginning of the month if you don’t already have one selected. Don’t forget, if you are a contractor, then you might need to deal with a specialist firm of Accountants for Contractors as there are also other considerations (we provided more details about this in Part 1 if you’ve only just joined us).

Choosing Your Accountant

What do Accountants Do?

Accountancy services are expensive and time based, but most start-ups will find the advice and potential financial benefits of hiring an expert accountant make this one of the most sensible investments for any new business. Effective accountancy support will minimize tax liabilities; avoid incurring financial penalties for failing to comply with company and tax regulations; and give confidence in reported business performance. The cost of an accountant needs building into a start-up’s budgets. You should appoint an accountant as early as possible.

There are six times as many accountants in the UK than family doctors, and more in the UK than the rest of the EU put together. Finding one is not a problem, finding one that will be right for you is.

There is confusion amongst many new business start-ups as to what an accountant actually does and this is not helped by accountants pushing add-on service which you may not need. So fundamentally an accountant produces accounts, which are a statement of a business’s performance over a particular period (usually a year) and its financial position at one time point (its year-end.) Other general services usually provided by accountants include: personal and corporate tax; payroll; business planning; and bookkeeping, whilst specialist services include audit; inheritance tax planning and trust work.

Choosing the Accountant for you.

The first step in choosing an accountant is to determine the services that you are going to use an accountant for and those that you will undertake in-house or subcontract to a cheaper specialist. What you should consider essential are:

General tax advice

An accountant is best placed to review your personal finances and expected business outcomes, and to advise on tax saving and prudent financial steps (e.g. whether you should be a limited company or a sole trader; how much of your income should be put away towards tax liabilities and the level of pension contributions you should be making; how best to take your earning in pay vs. dividends; and the most tax efficient method of financing a motor vehicle.) This is advice you need when you start in business and annually thereafter.

Preparation and submission of tax returns

Corporation tax returns and personal self-assessment returns are best left to an accountant to avoid errors and penalties.

Accounts

The finalization of the business accounts by an accountant will give reassurance to you on the accuracy of reported performance and give confidence to other parties such as banks and tax authorities.

Others divestible elsewhere include:

Bookkeeping

There are many excellent cloud computing package which integrate to the business bank account and create comprehensive electronic records of income and expenditure. These could be maintained by yourself or a member of staff or even an external bookkeeper. They usually have options to integrate VAT returns, and will enable you present a sensible set of management accounts to your accountant with him then being able to view any supporting documents immediately.

Payroll

Again there are many stand alone payroll packages available to operate yourself which are compliant. If this is going to take too much of your time because a large number of staff have to be paid weekly, then a payroll bureau is cost-effective.

Preperation

Prepare a written brief for the prospective account:

  • A personal summary of your income streams; assets and investments; mortgage and debt; pension provisions and tax history
  • A business description covering: industry; expected level of activity; employees; and funding availability.
  • These are the services I seek, and this is when I will need them.
  • This is how the business records will be kept, and the standard and detail of accountancy information available to you to undertake your service.

Selection Process

Go and see three prospective local Accountants. Ideally one who’s a referral from friends and family who have their own businesses, or by asking your bank; solicitor; or potential customers or suppliers to your business. If you can’t find any local accountants through referrals, you can always begin your search online. For example, if you live in London you would search for: London Accountants.

Once you’ve selected your favourites, contact them and ask for an initial consultation and discuss your business brief with them. Questions to ask them include:

  • Clients that they already have in your industry
  • Their experience with specific specialist services that you need (e.g. fund-raising)
  • How they can help you minimise potential tax liabilities compliantly
  • Their accessibility throughout the year if unforeseen financial problems arise
  • And of course likely fee levels for the services sought.

Then make the choice based on these meeting; the strength of the referral; and your view as to which accountant will best serve your needs.

The best way to ensure a successful relationship with your accountant over the longer term is to give him the information that you agreed to provide him with accurately and promptly. Pay him prompt, because most of his costs are payroll ones. When the accounts are completed annually make a point of going to see him to discuss them and the progress of your business. Ask him to explain anything that you don’t understand, and invite him to offer any suggestions for improvement. Remember that his fees are time based. Don’t make frequent calls to him for advice on matters that you could easily research yourself or could be addressed to a more junior member of his staff. Remember he is an accountant not a magician. Paying a large tax bill should be taken as a sign of business success in the knowledge that your accountant has done everything possible to minimise it.

 

The Bumps in the Road

For many start ups, the beginning can be a bit like living hand to mouth, and the financial bumps in the road caused by bad clients, poor cash flow etc, can be quite a challenge. If the challenges did become too much, you might find yourself considering Insolvency and in need of advice from an Insolvency Practitioner but I wanted this article to look at how to manage common financial issues (the big and the small) in the first months/years of a new start up business to avoid letting the bumps get the best of you.

Starting a business is a major life step change. There are many early financial challenges that need management and planning. Approach and execute these in a systematic way.

Planning

Planning a new business venture is fundamental to its success. Financial planning involves budgeting and putting required finances in place.

Budgeting involves estimating revenues and expenses for the business monthly, usually for its first three years. You need to be confident that the business will generate a profit after all costs, and enough profit to give you an income that you can live on.

You next need to extend that into a cash flow forecast which anticipates the bank receipts and payments monthly. This will indicate the finance requirements of the business, which will include monies you can invest in it at the start, and external finance such as a bank overdraft facility. If adequate finances are not available to fund the cash flow forecast, then the project is not viable. This could lead you to look at other potential sources of finance (such as crowd funding) revisiting the budget to cut its scale; or abandoning the project completely.

The final step is to test the model for risk. What is the effect on profitability and/or cash flow if: sales are 10% less than expected; stock purchase prices rise unexpectedly; or bank interest rates increase? You then need to consider strategies for these events, and look at ways of mitigating the risk. For example if the risk of a customer going bust before they pay you would devastate the business cash position to the stage where it would itself run out of money, then appropriate mitigation might be improved credit vetting procedures and taking out bad debts insurance.

Most new businesses fail because they run out of cash. As a general rule longer life assets (plant and vehicles) should be financed by long term finance (hire purchase or bank loan.) Other working capital cash requirements should be funded by cash introduced personally and/or bank overdraft. Be wary of introducing funding yourself that you have had to borrow personally (e.g. credit cards or home equity loans.) If the business fails then you are going to have to live with the consequences for years after.

Check with your accountant or tax helpline whether or not you need to register for VAT or PAYE. If you are liable to do so and do not do so then there are financial penalties and back-dated recoveries. With many businesses such as eBay traders, VAT registration can dramatically affect the profitability, and it may well be worth restricting the business sales to below the registration thresholds.

Recording

It is necessary to record the businesses actually performance to comply with tax legislation and also to see how actual results compare against your budgets so that you have early warning of potential problems and can act on them. There are a lot of time demands on the entrepreneur, and it is easy to under-resource bookkeeping and reporting at the price of say marketing activity. Follow certain rules to make the process simpler and more accurate.

Choose a simple bookkeeping system that is not over-sophisticated for the nature of what you are doing. Solicit external bookkeeping help if accounting matters are complicated or there are a large number of transactions.

All business expenses need to be recorded, otherwise a false picture of profitability is given. Many costs are incurred between having the business idea and achieving the first sale (e.g.: professional fees; marketing; company formation; visits to suppliers.) These are all business expenses and should be recorded as such. Similarly when the business starts you might use a personal asset (e.g. a laptop) for business use; use your own car; or dedicate part of your house for a business office. These costs should be apportioned and recorded.

Open a separate business bank account. All business transactions should go through it. Draw your salary to live on as one monthly amount. Don’t take out varying small amounts of money as personally needed. Don’t put any other personal expenses through the business account, and don’t pay business expenses through your personal bank account or credit card.

Prepare monthly accounts and don’t rely on the bank balance as a measure of success. Some of these bank funds may be PAYE or VAT and don’t belong to the business.

Consider using relevant tax elections available to reduce the administrative burden on small business (e.g. Annual PAYE; and the Flat-rate, Annual Accounting, and Cash Accounting VAT schemes.)

Monitoring

So we have a plan, and when we start trading a monthly record of how well we have done against that plan.

Act on any large negative variances, for example if sales fall below budget the need for greater advertising spend may be indicated. If things do not move to correct themselves in future months more dramatic action may be required: get a part-time job to supplement business income; or cut the size of the workforce.

On the other hand if things are going better than planned, don’t immediately take out a cash bonus for yourself. Recognize that individual monthly figures can be distorted, for example by seasonal trading. Rewarding yourself for good performance is better done after one year’s trading; in discussion with your accountant; and in consideration of the tax effects.

Business start-ups have a high failure rate. Some of these will be poor business ideas which were not viable in the first place. Much the larger number will fail because the entrepreneurs have neglected the financial planning recording and monitoring of their businesses. So to take steps to avoid that unpleasant winding up petition, begin with systematic approach to monitoring, then you can minimize the risk of failure, and reduce its effects if it does happen.