Small business accounting: Essential guide for UK businesses

Learn how to manage your small business accounts with our step-by-step guide.

Small Business Accounting

Most small business owners set out with a mission in mind – doing more of what they love. But a critical part of running a small business is managing your accounting, which can be a cause for stress if you’re not confident with the numbers.

Nailing the fundamentals can make you feel more comfortable with your finances, and help you make better-informed decisions. In this short guide, we cover the small business accounting basics, such as choosing an accounting method, tracking expenses and managing taxes.

Bookkeeping vs accounting for small businesses

Although the terms are often used interchangeably, there’s a difference between bookkeeping and accounting.

Bookkeeping is concerned with recording and organising financial data. Bookkeeping tasks involve coding transactions, matching receipts, invoicing and payroll.

Accounting is centred around the presentation and interpretation of that financial data. Accounting tasks involve preparing tax returns, generating reports and forecasts, and auditing.

That’s not to say your bookkeeper won’t handle tax, or your accountant won’t handle some small business bookkeeping tasks. You’ll need to do elements of both (or have them done for you) if you’re running a small business.

What’s involved in small business accounting and bookkeeping?

Small business accounting and bookkeeping can span a huge range of tasks. For the purpose of this section, we’ll focus on the jobs most small business owners will encounter. These are:

  • Recording, coding and reconciling transactions
  • Capturing receipts, invoices, and other evidence of income and expenditure
  • Invoicing clients and customers
  • Managing payroll (if you have staff)
  • Paying supplier bills
  • Managing cash flow
  • Creating financial reports and forecasts
  • Filing tax returns

In the early days, you might find it helpful to have a small business accounting checklist. Once you’re in the swing of things it’ll be easier to keep on top of your responsibilities, because you’ll know what needs to happen at certain times during the month.

How to do small business accounting

Different businesses will have different accounting needs. For example, freelancers and contractors may not have payroll duties, whereas larger businesses do.

How you manage your accounts is up to you. But there are certain steps that almost every small business will need to take in order to run a financially healthy and compliant business.

Here are some small business accounting best practices.

Do you need a business bank account for your small business?

If you’re operating as a sole trader – perhaps you’re a freelance designer or an electrician – you’re not legally required to have a business bank account.

As a sole trader, you are your business. It’s not a separate entity from you, so your bank account doesn’t need to be either.

But having a dedicated business account has lots of benefits. For starters, it’s easier to match receipts and evidence with transactions, since you won’t need to filter through personal transactions. And you’ll have a clearer view of your cash flow, because your account only shows the money moving through your business. Plus, if your venture really takes off, having separate personal and business transactions will make life much simpler when it comes to tax time.

Note: if you’re set up as a limited company, your business is a separate entity – so having a separate business bank account is for the best. Fortunately, there are plenty of basic business accounts to choose from.

Selecting an accounting method

There are two main small business accounting methods.

  1. Cash basis, where income and expenditure is recorded when you pay or receive money.
  2. Accrual basis, where income and expenditure is recorded when you raise a sales invoice or make a purchase, before the money has been transferred. So a bill is recognised as an expense, even if payment won’t be submitted for weeks.

Some businesses use a hybrid method of accounting that combines both methods. Day to day accounting is done using cash basis, but planning for big financial decisions is done using accrual accounting.

Not all businesses can use cash basis or hybrid methods, so it’s best to check the HMRC guidance on accounting methods first. Many businesses start off by using cash basis and progress to accrual.

For a deeper analysis of both methods, read our cash accounting versus accrual accounting guide.

Set up a chart of accounts

Small businesses need a chart of accounts before they can start categorising and reconciling their transactions.

But first – what is a chart of accounts (COA)?

A chart of accounts is a categorisation system for your business transactions. Much like a filing cabinet, every account type acts as a drawer, and each account code is a folder within that drawer. It’s essentially a guide for how you file income and expenditure in your business.

There are typically five account types: assets, liabilities, equity, expenses and revenue. For each account type, there’ll be a range of subcategories relevant to your business – for example, under expenses you might have advertising fees, subscription costs and entertainment fees.

Having a chart of accounts helps with small business bookkeeping because you can group income and expenditure together, and spot patterns and trends in how you spend and earn. You can also generate reports based on the data in your chart of accounts.

Keep track of expenses

One of the most critical aspects of accounting for small businesses is managing expenses.

Keeping an eye on your expenses is essential for tax purposes, but also for the general health of your business. If expenses are persistently higher than your income, you could end up in negative cash flow. If you’re not claiming allowable expenses, you could be overpaying on tax.

Hanging onto receipts, invoices, and other proof of sales and expenditure is also important. Though you won’t need to disclose evidence on your tax return, HMRC could request to see proof to make sure you’re paying the right tax.

These items are easily captured and organised with receipt capture tools. If you’re a Xero user, check out Hubdoc for effortless expense management.

How to reconcile your bank accounts

As a small business owner, you need to balance your accounting records with your bank records.

Closing balances on the bank records and accounting records should mirror each other, but this is rarely the case. Sometimes, customer payments bounce, or bank fees appear in the bank statement but aren’t listed in your accounting records until you reconcile them.

Here’s a quick guide to manually reconciling your accounts:

  1. Gather your bank records for the relevant period
  2. Open up your accounting system (this might be a spreadsheet, logbook, or ledger in your software)
  3. Find the last point your bank balance and accounting system balance matched – start here
  4. Check every transaction from your bank records against your accounting system
  5. Enter any missing transactions from your bank statements into your accounting system
  6. Once you’ve checked all deposits and withdrawals, check your closing balance on the bank statement and accounting system match. If they don’t, revisit the previous steps and double-check your calculations
  7. Read our in depth guide on how to do a bank reconciliation for more support

The longer you go without reconciling your accounts, the longer it will take to bring your books up to date. It’s also easier to remember the details of a transaction that happened weeks ago than one that happened months ago.

You can skip the hassle of manual reconciliation with small business accounting software, which automatically pulls through your bank records.

How to prepare for tax season

As part of your small business tax preparation, you’ll need to identify which taxes to pay. You may be a sole trader who pays income tax and VAT, or a company liable for corporation tax.

It’s best to register for the right taxes ahead of time because it can take HMRC a little while to get back to you. Tax season preparations for small business owners should include:

  • Maintaining complete and accurate records all year round
  • Having a secure and reliable method for capturing receipts, invoices and any other evidence
  • Completing reconciliation regularly (so you don’t have a mountain of work to do in one go)
  • Saving some of your income every month towards your tax bill
  • Making sure you have your UTR (unique taxpayer reference) number
  • Claiming the right allowable expenses (talk to an accountant or bookkeeper if you need help)
  • Marking the deadlines for different taxes in your calendar so you don’t miss them

You could also work with a professional who offers small business accounting services. The right accountant or bookkeeper can take many of these activities off your plate, and make sure you’re paying the right amount of tax.

Managing cash flow

The cash flowing in and out of your business is something you need to pay attention to. Positive cash flow months, where your income outweighs your outgoings, could be a good time to invest in new equipment or training. Negative cash flow months could mean you need to increase sales activities or cut down on expenses.

Managing cash flow can be tricky because it’s always changing. Every time an invoice is paid or an expense is cleared, your cash flow position changes. Here are a few techniques for keeping on top of cash flow:

  • Follow up on unpaid sales invoices promptly
  • Minimise your expenses
  • Set clear client payment terms and agree them upfront before starting work
  • Keep your bookkeeping up to date so you can see your live cash position
  • Produce regular cash flow forecasts so you plan for gaps and make investments at the right time

Small business accounting software can help you get a clearer picture of your cash position. With customisable reporting templates that let you analyse cash flow projections, you can spot gaps and protect the financial health of your business.

Managing late payments

One of the best ways to improve your cash flow is to clamp down on late payments.

Chasing up clients can feel uncomfortable, but there are several approaches you can take to get paid on time without spending hours on follow ups. You could try:

  • Introducing clear payment terms
  • Tightening up your approvals process
  • Automating invoice follow-ups
  • Introducing late payment fees
  • Requiring an upfront percentage fee

For more ideas, read our guide to managing late payments.

Setting up payroll

Before you can start paying employees, you need to follow these steps:

  1. Register as an employer on the HMRC website. Most limited companies and sole traders can do this online.
  2. Enroll for PAYE using your government gateway accounting and you’ll receive two letters:
  3. PAYE and Accounts Office references (within 15 working days); and your PAYE online activation code (within 10 working days).
  4. Find suitable payroll software.
  5. Using payroll software, you’ll need to submit a full payment submission (FPS) to HMRC every month. Ideally, you’ll want to choose a package that offers you other accounting benefits so you can manage more of your finances in one place.

Suitable software will help you store all of the payroll records that HMRC requires – such as payments to employees and deductions, payments made to HMRC, and taxable expenses and benefits.

Monthly reporting

Conducting monthly reports can help you understand the financial health of your business on a deeper level. Here are a few reports you should have on your radar:

  • Cash flow statement: This tells you how much money is flowing in and out of your business for operations, investments and financing. A cash flow statement will show you how much money is available in your business to spend.
  • Profit and loss report: This gives you a snapshot of your business’ income, expenditure, and profit or loss for a specific period.
  • Balance sheet: This tells you the value of what your business owns (including cash) versus what your business owes – namely the business assets, liabilities and owner’s equity.

Make monthly reporting a part of your small business bookkeeping practices, and you’ll have a clearer view of exactly how your business functions. Most accountants and bookkeepers can help you produce small business financial statements, or you can generate them yourself using cloud-based accounting software.

Consider using accounting software

For many small business owners, dealing with accounting responsibilities can be a real headache.

Small business accounting software can ease this stress – and give you peace of mind that you’re doing things properly. Many software packages allow you to automate financial admin and data entry, generate financial reports that are clear and simple to understand, and show you a live dashboard of your finances. So you always know where you’re at.

Software that combines AI and machine learning can even do some of the work for you – such as automatically importing your transactions, recommending receipt matches and account codes, and generating beautiful reports with accurate data.

With less manual admin, you’ll have more time to focus on the strategic aspects of your business – finding new customers, hiring staff, and developing your skills and products.

And when it comes to tax preparation, Making Tax Digital-ready software means you can file compliant returns now and in the future – without having to copy figures across multiple programmes.

Can anyone do accounting for a small business?

While it’s true that having a bookkeeper or accountant can make dealing with your business finances much easier, some small business owners choose to handle their own books instead. And having smart accounting software in place may give you the tools and capabilities you need to manage it yourself.

It’s also important to understand when you should hire an accountant – especially if your business is fast growing. Applying for a business loan, preparing for tax season, or growing a team are all examples of times where accountants and bookkeepers can provide great support and advice.

Getting behind on your books can quickly become stressful, and passing them over to a professional will prevent this from happening. Finding the right person can take time, but our Xero advisor directory is filled with talented accountants and bookkeepers who offer small business accounting services.

If you need more help deciding who to hire, read our guide outlining how to choose a small business accountant.

Make small business accounting easy

Accounting can be straightforward with the right software package.

Xero’s accounting software for small businesses takes tiresome financial admin off your hands, and gives you simple automations, customiseable reports, and live data to make running your financials a walk in the park.


Xero does not provide accounting, tax, business or legal advice. This guide has been provided for information purposes only. You should consult your own professional advisors for advice directly relating to your business or before taking action in relation to any of the content provided.

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