Accounting mistakes are common amongst those who manage their own finances. Accounting is a complex role, so without formal training, it would be unwise to expect yourself to be able to deal with every financial conundrum that comes your way.
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Previously, I’ve talked about some basic accounting mistakes that people often make and how to avoid them. However, there are plenty more issues to be covered. Today, we take a deeper look at accounting mistakes, tackling some more advanced problems and offering much-needed solutions.
Setting an Hourly Rate
Calculating how much you are going to charge as a self-employed worker is an incredibly important task — and it’s a figure almost everyone gets wrong.
Usually, the process starts with working out how much you should be earning and working your way backwards from there. However, the maths often become skewed and people find themselves charging less than they need to be, resulting in earnings below what they expected.
Here’s the problem.
Let’s say you decided-upon salary is £40k pre-tax. You then divide that by the average number of working hours in a year, which is 1950 (52 weeks x 37.5 hours a week worked). That gives you a rate of £20.51 per hour. But if you charge £20.51, you will not earn £40k. Why?
Because you will not work 1950 hours a year. Unlike traditional employment, being self-employed does not account for things like sick days, holiday leave, pensions or training time.
Thus, you need to take these types of time drains into account.
For example, on average, 9% of the working year is spent on holiday time, which means your rate must rise by 9% if you want to experience the same amount of holiday as somebody who is employed in the classic sense.
You’ll then need to account for sick days (4-5 days per year), pension costs (around 10%-15% of your income) and time spent honing your skills through extra training.
If we stick to the £40k figure, we’re now looking at an hourly rate of roughly £25.
You may be apprehensive about raising your rate, but you fail to adjust your hourly rate to include non-working hours, you’ll find you either have to work excessively to earn a living, or that’ll you’ll never achieve the earnings you desire.
Taking into account holiday, sick leave and pension alone, if you were to actually charge £20.51 per hour and work a normal working pattern, you’d actually be pulling in a figure far closer to £30k.
Claiming Unclaimable Business Expenses
Claiming business expenses is something all self-employed individuals must do if they hope to keep their running costs as low and efficient as possible. Yet, it’s not an area of tax management than many people fully understand.
There are some common misconceptions about claimable expenses that, if indulged, can have serious ramifications for your financial health. It’s important to know what you can claim on your tax return and it is also important to know what you can’t. There are a number of expenses new businesses believe to be claimable, only to find out later they will see tax relief for them. The result is the business is handed a tax bill higher than they were anticipating.
So what expenses are we talking about?
Client entertainment is a big one. Many business owners are under the impression that taking a customer out to lunch for a business meeting is claimable on tax returns, but in actual fact, you won’t see a shred of money back for your food. Similar to this is client gifts, like welcome packages or rewards.
Other common things people believe are claimable expenses but actually aren’t are legal fees, donations that are made outside of gift-aid, asset depreciation and fines or penalties. Before you start expecting tax relief for expenses, invest time in making sure they are actually claimable.
Charging Customer Expenses
Often in the service industry, you will incur some sort of expense for carrying out work. For example, you might use up resources on a job, or you may need to travel.
It isn’t something that we like to do, charging a business when they’ve already paid for our services, but it isn’t on you to cover the costs of a job you’ve been hired to perform.
Let’s say as a public speaker you have to travel to a conference. Paying for your own entrance fees, accommodation and travel is almost certainly going to make the job unprofitable, so you must claim those expenses back.
However, far too many people are claiming back costs incorrectly, leading to increased tax bills that could ruin their profit margins.
Before we can look at solutions, what exactly is the mistake?
What happens is this. You pay for hotels, flights, etc. You then send an invoice for costs and the business who hired you for your services pays those costs. Let’s say you’ve been paid £1000 for the job itself and the expenses come to £500. All sounds good so far — except it isn’t.
Now you are paid £1500 by the business to cover costs and expenses. When you file your tax return, you aren’t paying tax on £1000 worth of income; you are paying it on £1500. Over time, this significantly increases the amount of tax you are going to be charged.
I know what you are thinking: “I’ll just claim the costs as expenses on my tax return”.
This method will work, but only to a point. You can only claim so much on a tax return. Eventually, if you incur regular expenses during your self-employed work, you’ll find you are unable to claim back any more costs. That is when you really start to feel the pressure of this extra ‘income’.
Another problem that occurs is if you are paying VAT.
What you may end up doing is applying VAT only to your service, not the expenses incurred. However, as this counts as your income, you will pay VAT on both. Be sure to charge VAT for your service and any costs associated with your work. Otherwise, you’ll be paying extra tax charges.
The bottom line is this: don’t pay extra tax for providing your services. Ensure your clients cover all costs of expenses, either by charging extra on your invoice to cover appropriate taxes or by having them pay expenses out of their own business accounts, removing any impact it might have on your tax bill.
Other articles you might like:
Easily Avoidable Accounting Mistakes That Could Cost You Thousands
Why Online Accounting Works For Startups
About the Author
Russell Smith, a chartered accountant from Leeds, is a small business owner and finance expert. Russell is passionate about using his knowledge of finance to help small business owners, and he regularly blogs about important updates, as well as on good accounting practice.
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