When you start up in business, there’s a lot of information out there telling you how to do your bookkeeping or accounts on a day-to-day basis, but not much explaining the answer to the bigger question: Why do bookkeeping?
There are a few different reasons.
You need to know how much profit you made so that you pay income or corporation tax on that amount. You don’t need to pay these taxes on your entire turnover, just on your profit. To find profit, you want to remove the allowable expenses from your revenue; to do that, you have to keep accounts.
Tax codes are infamously long and complicated. The UK’s tax code is over 17,000 pages long.
Less well understood, though, is why. Successive governments of all stripes in basically all countries use the tax code to provide carrots and sticks to nudge the population into whatever the desired behaviour of the day is.
We’ve all encountered these carrots and sticks, probably most frequently at the supermarket. Many foods attract no VAT, and others now attract an extra sugar tax: both a carrot and a stick to nudge us.
Likewise in your business, some things are allowable business expenses and some things aren’t, simply because they are desirable or undesirable behaviour, or were at some point in history. There are other reasons things are written into the tax code, but this covers much of it.
When you set up your accounts, you’ll want to itemise expenses based on the type of expense.
For example, let’s say you sew things to sell, and you’ve purchased fabric, zippers, notions, an overlocker, business insurance, and bought a subscription to OK! magazine. Fabric, zippers, and notions can all go into one account; the overlocker needs to go into a separate (equipment) account; the insurance goes into a separate (insurance) account; the magazine needs to go into its own account.
Once you’ve done that, later on when you learn (or your accountant or qualified bookkeeper tells you) that you can’t claim OK! magazine as a business expense for your sewing business, then you are able to move the entire lot in one go out of your business accounts so you don’t file the wrong amount with HMRC and pay too little tax, which could result in fines.
There are less obvious cases where things are not allowed as business expenses based on your company structure, as well. If you’ve already categorised your expenses, it makes light work for yourself or your virtual finance director at the end of the year to make sure you’ve only included what you should.
Also, by breaking things out into separate accounts, you’re able to more easily glance through the lists and make sure they’ve been entered correctly. For example, insurance does not attract VAT, so if you’re VAT-registered, then before you file your VAT return, you’ll be able to look at your insurance account and just quickly make sure you haven’t accidentally entered any with VAT. Again, you’d then be reclaiming more VAT than you should (more than you’d actually paid), so that too could result in fines.
I think you get the idea. Stay tuned for more reasons to keep your accounts in future blog posts.