Category Archives: Expenses

Keeping an Eye on the Figures

 

Whether you are running a huge multi-national company or a tiny micro-business, it is essential that someone in the organization is keeping a close eye on the figures – essentially, how much money is coming in and how much is going out. In a large business, it may be a whole team of accountants and accounts clerks who are responsible for keeping track of the figures, but in a small business, it will often be the person or people responsible for the day-to-day running of the business who have to make sure that the figures are in order.

Cash Flow

Cash flow is quite possibly the single most important aspect of any business and can, when things go wrong, cause businesses to go under. Sometimes, even when a business is making plenty of sales, it can still go gust.  However, making plenty of sales and having money in the bank is not the same thing. It’s quite possible that you are signing plenty of deals but until you collect the money you can’t, in many cases, afford to spend it. Consequently, if sufficient money isn’t flowing into the business to satisfy creditors and suppliers when it’s needed, then trouble is probably on the horizon. In such circumstances, even profitable businesses can go bust.

Here are a few reasons why poor cash flow can cause businesses to get into difficulty:

  • Focusing on profit instead of cash flow (for example, a business whose fixed assets base is high and/or requires high working capital is likely to require more of the profits to be reinvested back into the business, thus reducing the cash available to service debts)
  • Ignoring the relationship between receivables and payables
  • Paying a supplier too quickly (always look at the terms of a contract and leave paying a bill for as is contractually acceptable)
  • Carrying surplus stock (until you sell a piece of stock it hasn’r made any money for you, and may well be costing you money in storage costs)
  • Being too slow to invoice (always get your invoices out as quickly as you can – the sooner you invoice, the sooner you will be paid)
  • Giving credit to the wrong customers (not always easy to avoid, but don’t ever get caught twice)

Gross Profit

Gross Profit is the difference between what an item costs and what it sells for. So, for example, if you pay £1 for an item, and you sell it for £5, the gross profit is £4.

If there are costs associated with, for example, the production of a product or service, these costs will play a part in the gross profit. For example, if a product costs £1 to buy and a further £1 to modify before it can be sold, and you sell it for £5, the gross profit will now be £3.

Gross Profit Margin

The gross profit margin is expressed as a percentage and is what remains from sales after a company pays out the costs of producing a product or service.

To obtain gross profit margin, divide gross profit by sales.

So, looking at the example above, if you receive £5 for the sale of an item, and it costs £1 to buy and a further £1 to modify, the gross profit margin will be:

Step 1: £5 – £1 -£1 = £3 (this is the gross profit)

Step 2: (£3 / £5) x 100% = 60% (this is the gross profit margin)

So, 60% gross profit margin means that for every £1 generated in sales, the company has 60 pence left over to cover operating costs (see below) and profit.

Here is a link to a Gross Profit Margin Calculator.

Net Profit

Net Profit is the difference between what an item sells for (£5 in our example above) and the costs associated with selling it. Here is an example:

Step 1: Add costs like rent, power, wages, advertising, delivery, and loan interest. These are the operating costs.

Step 2: Divide this figure by the number of items that you have (to sell). For example, £800 divided by 1700 (items) is 47 pence.

Step 3: Add this figure to the basic costs associated with the item (£2 + 47p = £2.47), giving you a net profit of £2.53 pence per item (£5 – £2.47).

Note that net profit is always smaller than gross profit.

Retained Earnings

Retained earnings refers to money that has not been paid out to shareholders in the form of dividends (see below for more information about dividends), but has instead been kept (retained) in the business. This money could then be re-invested in the business, for example, by training staff, buying new equipment, paying off debt, etc.

If the money is left in the company, it can be referred to as retained profit – money that has been kept in the company after all taxes, etc have been paid. It could then be used in future years, either to make dividend payments or to re-invest in the business.

If a business makes a loss, that loss is retained and called retained losses, accumulated losses or accumulated deficit.

Corporation Tax

Corporation Tax is a tax on the taxable profits of limited companies and other organisations including clubs, societies, associations and other unincorporated bodies. In the example given above, the taxable profits would be the net profit.

Taxable profits for Corporation Tax include:

  • profits from taxable income, for example, trading profits and investment profits (except dividend income which is taxed differently – see below for more information about dividends)
  • capital gains – known as ‘chargeable gains’ for Corporation Tax purposes

If a company or organisation is based in the UK, Corporation Tax will have to be paid on all the taxable profits of that company – irrespective of where in the world those profits are generated.

If a company is not based in the UK, but operates in the UK – for example through an office or branch (known to HMRC as a ‘permanent establishment’) – the company will only have to pay Corporation Tax on any taxable profits arising from its UK activities.

Corporation Tax – Financial Years

For Corporation Tax, the tax year is called the ‘financial year’ or ‘fiscal year’ and runs from 1 April to 31 March. This is different from the tax year for individual UK taxpayers, which runs from 6 April to 5 April.

Corporation Tax – Rates

There are currently two rates of Corporation Tax, depending on the size of a company or organisation’s taxable profits:

  • the lower rate – known as the ‘small profits’ rate
  • the upper rate – known as the ‘full’ rate or ‘main’ rate

There is also a sliding scale between the lower and upper rates known as ‘Marginal Relief’.

This means if a company or organisation’s profits fall between certain limits, it pays the full rate of Corporation Tax, which is then reduced by Marginal Relief.

Current rates of corporation tax for the financial year 2013-2014 are:

Small Profits Rate (up to £300,000 profit) = 20%
Marginal Relief Lower Limit = £300,000
Marginal Relief Upper Limit = £1,500,000
Main Rate of Corporation Tax = 23% (this will drop to 21% in 2014-2015)

Here is a link to a corporation tax calculator.

Dividends

Dividends provide a tax-efficient way of extracting funds from a company to make payments to shareholders of that company. In order for a dividend payment to be made, a company must have made sufficient net profit (see above) in either the current year, or have sufficient retained earnings in the company to allow the dividend payment to be made. For example, if a company has a gross profit of £10,000, corporation tax will be £2000 (using 20% as the corporation tax rate), leaving £8000 that can be distributed to shareholders in the form of dividends.

Dividend Tax Vouchers

When a dividend payment is made, a tax voucher must be raised and issued to the shareholder. In days gone by, this would have been done by post, but these days it is common to issue tax vouchers electronically.

The dividend tax voucher shows the size of the dividend and the amount of tax credit. The tax credit shows the amount of tax paid by the company on behalf of the shareholder. Dividends are paid after tax (at the basic rate) has been deducted. If you are a higher rate tax payer, you will probably have additional tax to pay on the dividends you receive. This will often be worked out by HMRC at the time of completing your self assessment tax return.

References

Corporation Tax – HMRC website

IT Contractor Expenses – Other Business Expenses

In addition to the expenses that we looked at in earlier posts, namely accommodation, travel, and subsistence, there are other business expenses that you might be able to claim during a contract assignment, or whilst trying to secure a contract. As with any expenses though, if you are unsure whether you can legitimately claim them, check with your accountant. For an overview of contractor expenses, see the Introduction.

The list of possible ‘other’ business expenses is:

  • Accountancy Fees
  • Approved Childcare Schemes
  • Bank Charges
  • Broadband
  • Business Insurances
  • Charitable Donations
  • Clothing
  • Computer and Other IT Equipment
  • Company Credit Card (fees associated with)
  • Company Secretary
  • Company Vehicles
  • Dry Cleaning
  • Entertaining Clients
  • Expenses incurred whilst trying to secure new contracts
  • Mobile Phones
  • Pension Scheme
  • Renting
  • Salary
  • Stationery
  • Subscriptions and Memberships
  • Training
  • Use of home for business purposes
  • Website Design and Hosting

IT Contractor Expenses – Subsistence

In the introduction, we took a look at contractor expenses and how they can be used to legitimately reduce a company’s corporation tax bill. In this post we will look at subsistence expenses in more detail. If you want to know about travel expenses, click here; if you want to know more about accommodation expenses, click here; if you want to know about other business expenses you might be able to claim, click here.

Subsistence claims are allowed if you have travelled in the course of your business, so long as you can prove that it was necessary to purchase a meal or drink whilst carrying out your contracting duties. You will need to keep receipts to support any claims you make.

Whilst claims for hot or cold drinks and food are allowed, HMRC will not accept claims for alcoholic drinks unless they are purchased as part of an evening meal.

IT Contractor Expenses – Accommodation

In the introduction, we took a look at contractor expenses and how they can be used to legitimately reduce a company’s corporation tax bill. In this post we will look at accommodation expenses in more detail. If you want to know about travel expenses, click here; if you want to know more about subsistence expenses, click here. A list of other business expenses that you might be able to claim is given here.

If you are having to live/stay away from home because of a contract, the cost is tax deductible. You are also able to claim £5 to cover personal incidental expenses for each night away in the UK, and £10 per night if you are contracting overseas.

Expenses incurred at the weekend are allowed so long as you are able to justify the claim. For example, a claim made for accommodation on a Sunday night is perfectly acceptable if you are required to be at your place of work early on the Monday (for example, 9 am), which would mean you having to leave home at 3 or 4 in the morning in order to get there if you were to travel on the Monday. You may also be able to claim if you are required to carry out work for the client during the weekend.

Check with your accountant for more information.

IT Contractor Expenses – Travel

In the introduction, we took a quick look at expenses and how they can be used (legitimately) to reduce a company’s corporation tax bill. In this post we will look at travel expenses in more detail. If you want to know about accommodation expenses, click here; if you want to know more about subsistence expenses, click here; a list of other business expenses you might be entitled to claim is given here.

The first thing to note is that the travel expenses mentioned below are subject to the 24 month rule, which we discussed in the introduction post. If you can’t remember what the 24 month rule is, I suggest that you go and have a quick look at the introduction new, just to familiarise yourself with it.

Bus, air, train, coach, and taxi fares, as well as parking and road toll charges may all be charged as travel expenses so long as they are incurred in relation to your contract.

Mileage

You can claim mileage costs incurred whilst travelling from your home or hotel to your place of work and back again. You can also claim mileage costs for any travel that you have to undertake during the course of carrying out work for the client, for example, if you have to travel to another one of your client’s sites.

HMRC approved mileage amounts that have applied since the 2011-12 tax year are shown in the following table.

Vehicle Type First 10,000 miles Above 10,000 miles
Cars and Vans 45p 25p
Motorcycles 24p 24p
Cycles 20p 20p

Passenger payments – cars and vans

You can claim 5p per passenger per business mile for carrying fellow employees in a car or van on journeys, which are also work journeys for them. Only payments specifically for carrying passengers count and there is no relief if you receive less than 5p or nothing at all.

For more information about travel expenses, refer to the HMRC web site. As always, if you are unsure about anything to do with travel expenses, refer to your accountant.

IT Contractor Expenses – Introduction

As an IT contractor, being able to take expenses out of your business is one of the perks of running your own limited company. The expenses have to be genuine though, and they have to be allowed by HMRC.

If you want to jump straight to information about specific types of expenses, use the following links:

The basic rule that you should always apply when trying to decide whether a particular expense is legitimate or not is to ask yourself the question “is this an essential business expense that has been incurred wholly and exclusively for my business?” If you can answer yes to that question then you’re probably fine in making the claim. If you are unsure, you should ask your accountant who will be able to give you an accurate answer.

There are basically two ways in which expense claims/payments can be made:

  • by using the company/business bank account to pay for the expense (for example, by company credit card or company cheque), or
  • by paying for the expense yourself and then claiming the money back from your company

In general, it is preferable to pay for expenses directly from your company bank account because there are some expenses that will not be allowable as deductible tax expenses (by the company) when reimbursing you personally for the same expense. In other words, if the company pays for the expense it can be offset against corporation tax, but if you pay for the expense yourself and then claim the money back from the company, the expense will not be offset against corporation tax. Talk to you accountant to find out which expenses fall into this category.

The 24 month rule

This rule was introduced in 1998 and basically states that you can claim personal expenses such as fuel costs and subsistence (meals and accommodation) if you have to travel to a place of work for a temporary (less than 24 months) period of time. If you know from the outset that the work is likely to last for more than 24 months, which is the case for a permanent job, you cannot claim the expenses.

Really, what the rule is stating is that if you live in Manchester, for example, and you take a six month contract in London, you’re not going to move house just for that contract. Instead, you will probably lodge Monday to Friday close to your place of work in London, and then travel back home at the weekends. It’s reasonable in this situation to be able to claim living and travel expenses associated with carrying out the contract.

If the contract gets extended for an additional year, but you believe that it will come to an end after that period, you can carry on claiming the expenses. However, if the contract then gets extended for, say, another seven months (taking you over 24 months in total), you cannot claim the expenses during those seven months because you know that the extension will take you over the two year mark.

Talk to your accountant if you’re not sure how to apply this rule. As with everything these days, there’s also loads of information available on the web and on the HMRC web site.

Update 30 November 2013 – Here’s another site to look at for information on IT contractor expenses: http://www.contractoruk.com/expenses/expenses_without_scandal.html