Sole Trader Bookkeeping: An Essential Guide

Sole traders usually work alone, so they often do their own accounting. Some sole traders hire an accountant to do this work for them, but many find that their financial records can be managed on their own.

Technically, ‘sole trader’ refers to a business structure that is subject to specific tax requirements. For this reason, it’s important to understand the best practices for financial record keeping for sole traders.

Key Takeaways

• A sole trader is a self-employed worker who collects all of their business income.
• Sole traders must pay tax on their income and submit self-assessments.
• Sole traders are just as subject to Making Tax Digital as any other business.
• A sole trader must pay Class 2 & Class 4 National Insurance alongside income tax.
• It’s important for sole traders to keep accurate records of all business expenses.

In this article, we’ll cover:

• Who Are Sole Traders?
• Responsibilities of a Sole Trader
• Record Keeping for Sole Traders
• How Will Making Tax Digital Affect Sole Traders?
• Bookkeeping Tips for a Sole Trader
• Conclusion
• Frequently Asked Questions

Who are Sole Traders?

A sole trader is a self-employed individual who collects all their income. A self-employed person who shares their income with a business partner is not a sole trader. Typically, the term ‘sole trader’ refers to a particular business structure and self-employed refers to how you pay tax.

Surprisingly, some sole traders have employees just like a small business. This on its own does not change their tax status as sole traders. However, some may be able to claim employee payments as business expenses. 

You must claim yourself as a sole trader if you make over £1,000 off your self-employed work per tax year. Many people claim themselves as sole traders before they hit that threshold. That’s because the status comes with benefits, such as tax-free childcare.

Responsibilities of a Sole Trader

A sole trader must fill out and submit a self-assessment tax return at the end of every tax year. If you have not done this before, you will need to register for a self-assessment tax return on the government website at least 20 business days before your tax deadlines.

Every sole trader must pay income tax on all profits. At public or private limited companies, income tax is automatically deducted from an employee’s paycheque. But a sole trader needs to pay this amount manually. 

You also must pay Class 2 & Class 4 National Insurance within 3 months of becoming self-employed. You might not have to pay both. You need to pay Class 2 if your annual income is over £6,475 and Class 4 if it’s over £9,501.

A sole trader also must register for VAT if they have a turnover above £85,000 or want to reclaim VAT on sales made to VAT-registered businesses.

Record Keeping for Sole Traders

No matter how you run your business, you need to submit certain records to the HMRC. At minimum, you should preserve:

• All records related to taxable income
• VAT records (if applicable)
• Evidence of any grants from the Self-Employment Income Support Scheme (SEISS)
• Business bank records (if you have a separate business bank account, use your records from there)
• Receipts for any business-related expense

The HMRC recommends that businesses preserve their financial records for the next 5 years. This also applies to the self-employed. 

Paper records aren’t required by the HMRC. In fact, it’s best to move away from them. With Making Tax Digital (MTD) rolling out, it’s advisable to get used to a digital system. It’s also much easier to keep all of your records organised when they’re on an accounting software.

While choosing a sole trader accounting software, it’s tempting to go with the cheapest. However, the lowest cost tool may not be the best accounting software. You need something that’s MTD-compliant and is able to handle fluctuating income. FreshBooks is both. Additionally, you will also need an online accountant. In partnership with Mazuma, FreshBooks provides sole traders in the UK with online accounting services. 

How Will Making Tax Digital Affect Sole Traders?

Making Tax Digital is a UK government initiative intended to make tax paying simpler and more accurate. Accounting software is less prone to human error than manual records. So, the HMRC would like business owners to start submitting tax records digitally.

VAT-registered sole traders are already subject to MTD. After April 2026, this will extend to all unless they are exempt. As a sole trader, you must use MTD-compliant software like any other business.

Note that the rollout of MTD also means that the annual self-assessment process will come to an end. Instead, you will need to submit your self-assessment tax return on a quarterly schedule. 

In the grand scheme of things, MTD will make things much easier for sole traders. Digital bookkeeping and tax paying will save time and prevent mistakes. Bear in mind that MTD for ITSA will only affect sole traders who make more than £50,000 per year.

Bookkeeping Tips for a Sole Trader

Having a separate bank account is not a legal requirement. However, some find it easier as it keeps their personal expenses separate. Bear in mind that some banks will charge extra if you open a second bank account. 

It’s much simpler and more cost-effective to use bookkeeping best practices when you keep your personal income and expenses separate. Here are some top tips on sole trader bookkeeping.

• Be proactive: Don’t leave your bookkeeping tasks until the end of the tax year.
• Set aside at least 30% of your profit to cover National Insurance.
• If you are mixing permanent employment with freelancing, be careful not to pay National Insurance twice.
• Claim as many business expenses as you can—anything from stock, to internet bills, to uniforms could qualify.
• Digitise your records but hang on to your paper receipts. They may come in handy as back-up records. If you’re ever audited by the HMRC, you’ll need these to prove relevant expenses.
• Don’t delay payments: Pushing back payments now creates debt later. This will hurt your cash flow.
• Use accounting software to make everything easier.
• There’s no shame in speaking to a professional accountant if you’re feeling overwhelmed.

Boost your efficiency and focus on your core business activities by partnering with an online accountant near you. Our Online Accountants page offers access to a network of accountants experienced in providing personalised bookkeeping solutions for sole traders.

Conclusion

Bookkeeping for a sole trader is not too different from bookkeeping for other small businesses. Anyone who earns income must track their business finances and file tax returns. The most striking difference is simply the need for self-assessments and the likelihood of business owners doing their bookkeeping themselves.

FAQs on Bookkeeping as a Sole Trader

What are the basic bookkeeping tasks that every sole trader should perform?

Every sole trader should follow these 6 bookkeeping steps.

1. Create a chart-of-accounts
2. Collect all business transaction records
3. Record all transaction information on an income statement
4. Add other business expenses not found on your records
5. Deduct any tax write-offs if applicable
6. Submit your income statement as your income tax self-assessment return

What are common mistakes sole traders must avoid when it comes to bookkeeping?

The most common bookkeeping mistake a sole trader can make is failing to keep relevant receipts. Every business expense can count towards your tax records. You may claim business expenses on anything that helps you work, even if it’s not obvious.  

What is the difference between accounting and bookkeeping?

Bookkeeping is simply record-keeping. Accounting is financial analysis. A bookkeeper records and maintains accurate records while an accountant makes sense of financial data. You are not expected to perform in-depth financial analysis, but keeping track of your accounting records is important.

What are the benefits of maintaining good bookkeeping records for a sole trader business?

Sole trader businesses are required to maintain good bookkeeping records. Self-employment means submitting self-assessments, and you need good records to do that accurately. Beyond that, it’s also helpful for a sole trader to have a clear view of their financial position.

What should sole traders look for in a bookkeeping system?

Sole traders should seek a bookkeeping system that is good with monthly records. Bookkeeping requirements are much lower than that at a private or public limited company, so there is no need to overcompensate. Double-ended bookkeeping is also popular among sole traders.

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