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A lot of business owners set up their business as a 'sole trader' when they first start out. It's the simplest way to set yourself up.
It's quick and easy to do. You will need to let HMRC know that you are in business as a sole trader as soon as you start trading and register with them as self-employed. You will need to fill in a self-assessment tax return (currently annually) so that HMRC can charge you income tax on your profits. You will also pay some National insurance too.
Although you won't have to publicly report your figures, keeping records of your sales and purchases is really important to enable you to prepare your tax return. These records will also help you know how you're doing in your business - are you making a profit or a loss?
PROS
Straightforward to set up. Very little paperwork or legal tasks to do. No reporting requirements other than the tax return
CONS
You and the business are the same legal entity. If you can't pay your bills, your suppliers could seek payment from you directly. You are personally liable.
A company is entirely separate to you as the business owner and separate to any directors and shareholders. It exists in its own right and contracts with suppliers, invoices customers, and has its own bank account.
Why would you set this up instead of operating as a sole trader?
Well, you may be someone who, having considered the risks associated with their business, decides that you would like further protection than that offered by the sole trader model. The most you can lose is the money you have put in in shares. Note though that as a director of the company you will have some duties and obligations in law and a company structure won't protect you from everything (for example if you have operated negligently) but it does limit your liability compared to a sole trader. It doesn't remove all the risk
Another example is that some business owners feel that a limited company structure gives them greater standing with customers and suppliers - they feel that they are viewed as a more legitimate business.
You need to register as a company with Companies House and will get a company registration number.
The company will have its own Corporation Tax to pay on the company profits. Directors will still need to complete a self assessment tax return.
The company bank account doesn't belong to you as a director. Money can be taken out either as a salary or as a dividend or both.
There is more administration to do compared to a sole trader - for example the company has to file annual accounts, file a confirmation statement and a corporation tax return.
What are accounts? Well they are a way of presenting how your business is performing in terms of its financial results .
A profit and loss account relates to a specific period of time - for example a month or a year - and shows whether you are making a profit or loss for that specific period. Typically a profit and loss account will show your sales, your costs, your gross profit and your net profit.
A balance sheet shows your financial position at a point in time (rather than for a period of time like the profit and loss account). So it will show what assets you have (for example equipment, money owed to you) and what liabilities you have (for example money you owe to suppliers, loans you have) at a specific date (e.g your month or year end).
What are management accounts? Unlike statutory accounts which have to be filed with Companies House in a specific format, management accounts can be in any format you wish to suit your specific business.
They can be produced monthly or quarterly. Typically they would include a profit and loss account and balance sheet, but may also include comparison of actual performance to budget or forecast with detailed analysis of reasons why the business has done better or worse than expected. They may include a comparison of how the business has performed against previous year results. The accounts could include results for the month, the quarter and the year to date.
You may decide you're more of a visual person and would like the results shown in pie charts or graphs rather than tables of numbers.
The business may decide that trends are important.
Management accounts are yours and can be tailored to meet your requirements.
These are a set of financial reports (sometimes called financial statements) produced annually and they have to be filed with Companies House if you are a limited company. There are a number of specified formats suitable for different sizes of company. They all include a balance sheet and profit and loss account and some further information in the notes to the accounts. These accounts are publicly available on the Companies House website to anyone, but they don't include every last detail of your income and expenditure.
There are a number of ways of describing profit which can sometimes get a bit confusing. Gross profit is calculated by deducting direct costs (cost of sales) from income. What are direct costs? Well, these are costs which you only incur in order to make sales. If you stopped selling you wouldn't incur these costs. So for example, you may incur costs to deliver your product to suppliers. If you didn't make any sales, you wouldn't incur any delivery costs. These costs are variable.
So you have your gross profit - what next. You may incur a number of other costs such as rent, rates, IT support costs ,and so on. These costs are incurred regardless of the number of sales you make. So if you made zero sales in a month, you would still have to pay your office rent for example. These costs are usually fixed for a year and can also be described as indirect costs or overheads. If you deduct these from your gross profit, you end up with your net profit.
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