Although not one of the most glamorous parts of running your own business, knowing how to use and track expenses is essential. However, for many small businesses, understanding exactly what can be expensed and how to track claims can be tricky. This can be especially true of new business owners with no previous experience of corporate expenses.
In this guide, we take a deep dive into this aspect of running a business. We explore what the term ‘expenses’ actually covers in the context of a small business, and explain why tracking is so important. Finally, we look at some of the ways businesses can keep on top of tracking their expenses.
In its simplest form, an expense is any cost experienced by a business that is directly related to revenue generation. Expenses include everything from employee salaries and work premises overheads to the cost of business insurance policies and certain training costs.
With rules set by HMRC in the UK, there are two main categories of business expenses. These are tax-deductible and non-tax deductible expenses. While all expenses must be tracked, the way in which they are recorded in a business account and tax returns will vary depending on which category they fall into.
Tax-deductible expenses are costs that are wholly and inclusively incurred by a business and can therefore be set off against profit, resulting in a smaller tax bill. In order to be a tax-deductible expense, costs must be seen as essential in the running of a business in the eyes of HMRC. For example, a taxi business, or any other business that uses vehicles, could claim the cost of its vehicles, fuel and any maintenance work needed to keep vehicles roadworthy as tax-deductible expenses. This is because the business couldn’t run without these things.
On the other hand, non-tax-deductible expenses cannot be deducted from a business’s declared profits. This means they do contribute to a company’s final tax bill. Expenses of this kind are deemed non-essential in order for normal business operations to occur. Examples of non-tax-deductible expenses include client entertainment costs, regulatory fines/penalties, and depreciation.
Yes – most business insurance policies are classed as a tax-deductible expense. For example, the likes of professional indemnity and public liability insurance are considered ‘allowable expenses’. This means the cost of these policies can be deducted when you calculate taxable profits each year.
There are three main reasons why tracking business expenses is so important:
– You can pay less tax
As discussed above, when returning your annual tax return, you are taxed on your business’ total income, minus all tax-deductible expenses.
For this reason, it quite literally pays to track your business expenses carefully. By keeping meticulous accounting records and managing your expenses on a regular basis, your business keeps a larger proportion of its profits.
– It makes tax returns easier
Tax returns are important. If your business fails to comply or submits its tax returns late, it can face financial penalties. By tracking your expenses as you go – rather than collating relevant bank statements and receipts at the last minute – you make the whole process of completing your tax return much less stressful. Regularly tracking your business expenses will also help you to justify your position to HMRC should they ever challenge your tax return.
– You can keep tabs on your business’s financial health
By maintaining a clear and up-to-date set of business accounts, you can get a better understanding of your business’s financial health. Different businesses experience different cash flow situations, seasonality patterns, and periods of growth. This means if you lose track of your expenses updates, it can be hard to get a clear picture of your business’s financial situation. On the other hand, staying as up-to-date as possible gives you the most accurate impression of how your business is performing.
Although some small businesses do still track their expenses manually, this practice is becoming rare. Filing away receipts and keeping track of all expense claims in ledgers is considered outdated. In fact, it will soon be a requirement for many small businesses, as from April 2024, all UK businesses with a turnover over £10,000 but falling under the VAT threshold of £85,000, will be legally obliged to keep digital accounts. This legislation is part of HMRC’s Making Tax Digital (MTD) initiative.
Accounting software is designed to make recording, archiving and analysing income and expenditure data simple. It also reduces instances of human error, giving business owners and HMRC a more accurate picture of a business’s financial health. Under MTD, the majority of small businesses will have to track their expenses in this way.
When you run your own business, there’s always the chance that you could be approached by HMRC for a tax or IR35 investigation. With HMRC being able to randomly select one out of every 1,000 tax returns each year for scrutiny, you never know if it could be you. With this in mind it can not only pay to manage your expenses efficiently but also to consider protecting your business and finances with legal expenses insurance.
Click here to learn more about Tax Enquiry & Legal Expenses Insurance or alternatively, contact our award-winning team on 0333 321 1403.