Sole trader vs limited company: changes in monthly accounting

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Every business – no matter how small or big – must have a legal structure, with the majority preferring to be either a sole trader or a limited company. 

An estimated 3.5 million business entities operate as sole traders in the UK, with a further 2 million operating as a limited company. 

There are pros and cons to both, however, which could be the best fit for your business when it comes to doing the monthly accounting?

Post summary:

  • What is a sole trader? What is a limited company?
  • Sole trader vs limited company?
  • Differences in monthly accounting for both 

What are sole traders and limited companies?

Sole traders

Sole traders are self-employed individuals who are the sole owner of their business. As a legal business entity, it remains the most straightforward, hence the most popular option.

Limited companies

A limited company is a business structure that has its own legal identity, separate from its owners (known as shareholders) and those who manage the business (known as directors). If one person runs the business (acting as shareholder and director), it is still a limited company. 

Sole trader vs limited company?

Determining whether to be a sole trader or limited company depends on each’s businesses circumstances. For business owners, there are advantages and disadvantages of both legal entities. 

Advantages of being a sole trader

  • Easy to get set up and less paperwork, except for an annual self-assessment tax return.
  • More privacy than limited companies, whose details are listed via Companies House.

Disadvantages of being a sole trader

  • Sole traders have unlimited liability, as they are a separate legal entity under UK law. Meaning that if the business drops into debt, the business owner is personally liable. Assets of the sole traders could be lost to repay debts. 
  • Raising financing is more complicated, as banks and investors prefer limited companies with their limited liability. Thus limiting possible business expansion opportunities.
  • Tax rates on sole traders are not as competitive compared to limited companies. Once a certain level of revenue is, it may not be quite as lucrative to remain a sole trader.

Advantages of being a limited company

  • A limited company has the advantage of limited liability, as incorporation forms a separate legal distinction between the business owner and their business. Meaning that personal assets reached are not endangered.
  • Limited companies are more tax-efficient than sole traders. Corporation Tax is paid on profits, rather than Income Tax, where the percentage rate is higher. 
  • A company name is protected, nobody else is permitted to use it, unlike sole traders who are not entitled to register a business name. 

Disadvantages of being a limited company

  • More administrative work is costly and time-consuming. Directors must either deal with this additional administration themselves or hire accountants to deal with it
  • Business information is found via Companies House, details on the company’s directors and earnings are required to be publicly listed. For several businesses, this may not be conducive.

How does this impact your monthly accounting?

Filing of annual accounts

The main challenge of choosing a limited structure as opposed to a sole trader is that as a limited company director, you must prepare annual reports. These are filed with the Companies House. 

Furthermore, directors must file full corporation tax accounts with the HMRC. However, sole traders are under no obligation to do so. 

All annual financial accounts must be ‘true and fair’, with all business records held for a minimum of 6 years from the end of their relative accounting periods.

All accounting records must provide details of the following:

  • All the money the business receives and spends.
  • All business owned assets.
  • All debts (if any) the business owes or is owed.
  • Stock inventory owned by the business at the end of its relative financial year.
  • The stock takings used to determine the stock inventory.
  • All business goods bought and sold.
  • Where goods were bought and sold, with the exemption of retail trade.

These financial records are utilised to prepare full (‘statutory’) annual accounts, pay any Corporation Tax owed and file any Company Tax Returns. 

Should a company’s annual turnover exceeds the Value Added Tax threshold (currently £85,000 for the 2019-20 tax year), a company director must file VAT returns and pay VAT bills every quarter.

With the changing nature of accounting, with government initiatives like Making Tax Digital, it is more imperative than ever for limited companies to their keep records in check.

If the monthly bookkeeping is more streamlined for sole traders, why become a limited company in the first place?

Tax

One word: potential profitability. A limited company is more tax efficient.  

As mentioned above, limited company owners only have to pay corporation and dividend taxes, which are much lower than income taxes. 

A sole trader will pay tax on all of their profits that are above their personal tax allowance, which is set at £12,500 for the current tax year. 

A sole trader will need to ensure they:

  • keep records of their business’s receipts, and expenses
  • file a Self Assessment tax return each year
  • pay Income Tax on their profits and Class 2 and Class 4 National Insurance 

Plus, if they earn over £85,000 per tax year, they will need to register for VAT and submit VAT returns the same as a limited company.

Final thoughts

A limited company does appear as a better business entity to be than a sole trader, due to the limited liability and potential profitability of a limited company. 

Businesses, clients and contractors are more likely to work with limited companies as their perception is that a limited company has grown, has more financial assets, has a bigger team behind it and this appears more professional. 

This additional credibility is more reputable, meaning newer customers and businesses will choose to work with you. A sole trader appears to others as a “one-person” entity, even if the sole trader has other workers doing tasks for them.

A sole trader legal business structure is the easiest to start and manage each month, has less monthly administrative and bookkeeping, and this is why it is the most popular option for UK businesses.

However, it should be noted that although you can handle all the monthly accounting by yourself, the higher volume of business usually translates to more monthly accounting. 

It may be a better solution to hire a monthly accountant to ensure your bookkeeping is adequate for HMRC.

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triin

triin

CEO & Head of Growth