In this article, we will explore some fundamental concepts that are essential to grasp when it comes to tax and accounting. It’s common for individuals to find the terminology confusing, especially terms like “turnover” and “profit.” To help alleviate this confusion, we will define key terms such as turnover, expenses, profit, and accounts, and explain their significance for tax and business purposes. Additionally, we will discuss the basics of business structure and tax obligations for different types of businesses. By the end of this article, you will have a clearer understanding of these fundamental principles, enabling you to navigate the world of tax and business with confidence.
Definitions
Turnover
Turnover refers to the total amount of self-employed income you earn from clients, customers, and subscribers. It is also known as “takings,” “sales,” “business receipts,” “gross income,” or “business income.” This is a crucial figure for calculating your business’s financial performance.
Expenses
Expenses are the costs or outgoings incurred in running your business. These can include overhead costs, such as rent, utilities, and insurance, as well as any other expenses related to the operation of your business.
Profit
Profit, also known as net income, is calculated by subtracting your expenses from your turnover. It represents the amount of money you have left after covering your business expenses. Profit is an essential indicator of your business’s financial success.
Accounts
Accounts refer to the summary of your turnover, expenses, and profit, which is used to report your business’s performance for tax and management purposes. It includes financial statements, such as a profit and loss account and possibly a balance sheet. These accounts are drawn up for your financial year, which is typically the tax year but can also be a calendar year or the anniversary of starting your business.
Bookkeeping
Bookkeeping involves keeping records of your turnover and expenses for accounting purposes. It is crucial for accurately tracking your business’s financial transactions and ensuring compliance with tax regulations. Bookkeeping can be done using various methods, including paper records, spreadsheets, or specialized software or apps.
Why is this important?
Establishing Turnover and Profit
Determining your turnover and profit is essential for tax purposes. Income tax, under the self-assessment system, is based on profit. Similarly, corporation tax for companies is also calculated based on profit. Therefore, understanding and accurately establishing your turnover and profit is vital for ensuring you pay the correct amount of tax.
Tax Purposes
Understanding the terminology of turnover, expenses, and profit is crucial for fulfilling your tax obligations. It allows you to accurately report your business’s financial performance to HM Revenue and Customs (HMRC) and ensure compliance with tax laws and regulations.
VAT
VAT, or Value Added Tax, is based on turnover. If your business’s turnover exceeds the registration threshold, which is currently £90,000, you will need to register for VAT. Understanding the concept of turnover is therefore essential for determining whether your business needs to comply with VAT regulations. Additionally, some expenses incurred for VAT-registered businesses may be deductible to reduce the VAT bill.
Common Terminology
Becoming familiar with the terminology used in business accounting and taxation is crucial for effective communication with various stakeholders. This includes HMRC, tax authorities worldwide, banks, accountants, advisers, and others involved in the business world. Understanding the common language used in these contexts will enable you to navigate the business landscape more effectively.
Business Structure Basics
Sole Trader
A sole trader is an individual who runs a business as the sole owner. This is the default structure for businesses, and it offers simplicity and flexibility. As a sole trader, you are personally responsible for all aspects of the business and its finances. This means you have unlimited liability for any business debts or losses. Income tax is paid on the profits of the business as part of your personal income tax return.
Partnership
A partnership is a business structure where two or more individuals own and operate the business together. Partnerships can be formed as general partnerships or limited liability partnerships (LLPs). In a partnership, each partner contributes to the business and shares in the profits and losses. Partnerships are also taxed based on their share of the partnership’s profits, with each partner reporting their share on their personal income tax return.
Limited Company
A limited company is a separate legal entity from its owners, known as shareholders. It offers limited liability protection, meaning that the shareholders’ personal assets are generally protected from the company’s debts and liabilities. A limited company is subject to corporation tax on its profits. The directors of the company may also receive a salary, which will be subject to income tax, and the shareholders may receive dividends, which are taxed at a special rate called “Dividend Tax.
Tax Basics
Taxation of Sole Traders
As a sole trader, you are taxed as an individual. Your profits from the business are combined with any other income you may have, such as income from employment or rental properties. The total income is subject to income tax through the self-assessment system. It’s important to note that not all yoga teachers fall into the sole trader category, as some may operate through a partnership or limited company structure.
Taxation of Partnerships
Partnerships, including LLPs, are taxed differently from sole traders. Instead of the partnership being taxed as a separate entity, each partner is individually taxed on their share of the partnership’s profits. This means that each partner includes their share of the partnership’s profits on their personal income tax return under the self-assessment system.
Taxation of Limited Companies
Limited companies have their own separate legal identity and are subject to corporation tax on their profits. The directors of the company may also receive a salary, which is subject to income tax. Shareholders of the company receive dividends, which are taxed at a special rate known as the “Dividend Tax.” It’s important to carefully manage the tax obligations for both the company and its directors and shareholders to minimize tax liabilities and ensure compliance with tax laws.
VAT
Value Added Tax (VAT) is a consumption tax that is added to the price of goods and services. VAT is based on your turnover, and if your business’s turnover exceeds the VAT registration threshold, you must register for VAT. This means you will need to charge VAT on your sales and account for it to HMRC. It’s important to understand when and how VAT applies to your business to comply with VAT regulations and avoid any penalties for non-compliance.
Accounts Basics
Bookkeeping
Bookkeeping is the process of keeping records of your business’s financial transactions. It involves recording your turnover and expenses in a systematic and organized manner. Bookkeeping can be done using various methods, such as using paper records, spreadsheets, or specialized software or apps. It is important to maintain accurate and up-to-date bookkeeping records to ensure compliance with tax regulations and to have a clear understanding of your business’s financial performance.
Accounts
Accounts, also known as financial statements, provide a summary of your business’s financial performance. They typically include a profit and loss account (sometimes called an income statement) and may also include a balance sheet. Accounts are prepared annually and can help you assess your business’s profitability, financial stability, and cash flow. Many businesses engage accountants to prepare their annual accounts to ensure accuracy and compliance with accounting standards.
Tax Return
A tax return, also known as a self-assessment, is the return you submit to HMRC reporting your taxable income. For individuals, this is done through the self-assessment system. Your tax return is typically based on the information from your accounts, including your turnover, expenses, and profit. Engaging an accountant, such as YogaTax, can help ensure your tax return is prepared accurately and in compliance with tax laws.
Understanding the basics of turnover, expenses, profit, accounts, and bookkeeping is crucial for managing the financial aspects of your business effectively. It allows you to accurately report your business’s performance, fulfill your tax obligations, and make informed financial decisions to support the growth and success of your business.