Sole Trader or Limited Company
Having done everything in the previous articles (or maybe before then) you need to decide how to trade; do you set up as a Limited Company from the start or do you begin as a Sole Trader?
As a Sole Trader you are essentially self-employed. It’s is by far the simplest way to start and run a business which is why it’s the most popular choice with approximately 3.4 million people in the UK choosing this option compared to around 1.9 million Limited companies which currently exist.
One of the advantages of being a Sole Trader is that there is very little paperwork involved other than an annual Self Assessment tax return which can be completed by an account or yourself. They are also very easy to not just set up but also close down which makes it appealing for those who want the ‘test the water’ before committing to a Limited Company.
You can register as a Sole Trader on the Gov.uk website.
One of the reasons limited companies exist is to limit the liability of the owner. A limited company is viewed as a separate legal entity to the people who own and run it. A sole trader takes on full responsibility for the company so, should a sole trader get into debt, the owner is personally liable.
As the owner of a limited company you are generally only liable for what you have put into the company and are unlikely to loose personal assets.
A limited company also looks more professional – this is particularly important if your customers are other business; it send the message that you are not just a legitimate operation but also business minded. Similarly banks favour lending to Limited Companies rather than sole traders, which would essentially be a personal loan, so raising finance as a sole trader, especially a s new start up, can be difficult.
There are also tax benefits to limited companies. Instead of paying income tax as a sole trader, the limited company pays corporation tax. There are other tax benefits which allow the owner to offset purchase and assets against their annual corporation tax bill.
Setting up a limited company is not particularly difficult either. Once you have registered as a limited company with Companies House, no one else can use that business name which prevents others from ‘copying’ your image.
With all of these benefits comes added responsibility and an increased burden of work. There is generally more paperwork involved, especially in the form of accounts and finances which means that unless you are already clued up on current financial rules, corporation tax, PAYE (which will be how you salary is paid), National Insurance and tax breaks you will need an account.
As a sole trader if you have a good friend who is financially literate they may complete your self assessment for you simply as a favour. A chartered accountant will charge anything from £500 to over a thousand pounds for completing all of the accounts for a limited company but in general a good accountant will easily save you and your business more money than they charge. As well as saving you money the penalties for incorrectly submitting accounts are not just financial but can also be criminal.
As director of a limited company your personal details and a summary of the businesses finances are publicly available.
Which is best?
If you are new to the industry, sole trader is the best option initially; it allows you to get a feel for the market and the industry without too much commitment or costs. Many people, once established will then upgrade to a limited company.
Whilst starting out many First aid trainers freelance as instructors or assessors for other companies as well as running their own private courses. And there is no shame in that! Freelancing for other First aid training companies not only provides additional income but also additional hours for your CPD portfolio and will expose you to a wider range of candidates and industries than you may be targeting with your own customers as well as the opportunity to observe other trainers and assessors.
Other companies often view limited companies as more of a threat – they may be concerned that they are giving an established competitor access to their customers. Operating as a limited company may reduce the amount of freelance work which comes your way.
Conversely, larger businesses generally prefer to engage with other limited companies so once established as a sole trader, upgrading to a limited company may then open up opportunities which weren’t previously available to you as a sole trader.
Should I go VAT registered?
VAT registration is an obligation for businesses whose turnover is above a certain threshold; as of 2017-18 (and until 2019-20) the threshold is £85,000. Once your business reaches this in a 12 month period or if you expect it to, you must register for VAT. For a new First aid training business, turning over £85,000 (over £7,000 a month or £1,600 a week) is exceptionally rare!
Companies can also voluntarily register for VAT. Why would you do that?
Being voluntarily VAT registered looks good to larger clients. It gives the impression you are larger than you are. Businesses – including competitors – will probably be aware of the VAT threshold so if you are not VAT registered they will know your turnover is below that threshold. Whilst a Sole Trader can become VAT registered, VAT registration is normally the next step for limited companies.
There can also be financial benefit to VAT registration. Being VAT registered means you are able to claim back VAT spent on things that you buy into the company. You will never profit from this because if your VAT expanses are greater than your VAT income it means you are spending more than you are earning!
If you voluntarily register for VAT you may prefer to register under a Flat Rate Scheme. These schemes do not let you claim back VAT paid but you ay a reduced amount of VAT in return, The benefit of a Flat Rate Scheme is the comparative simplicity of the accounts.
Limited Cost Trader
Limited Cost Trader is a Flat Rate scheme applied to businesses which spend less than 2% of their VAT inclusive turnover (or less than £250.00) per quarter on goods. Goods are generally considered as stock or consumables which are brought into the business and used as part of the product or service. They do not include:
Services such as accountancy fees, advertising costs or hiring of equipment.
Food and drink for you or your staff.
Fuel for a car (this is excluded unless operating in the transport sector using your own, or a leased vehicle).
Laptop or mobile phone for use by the business (excluded as it is capital expenditure).
Anything provided electronically, for example, a downloaded magazine, journal article or software.
Rent or utilities.
For a First aid training business, ‘goods’ would generally be considered as ‘consumables’; items which come into and go out of the business such a gloves, flip chart paper and bandages.
Under this scheme you charge 20% VAT on all goods and services but you pay 16.5% VAT to the government.
For example, if you were to charge £100 plus VAT for a service you would charge the customer ( £100.00 x 1.2 = ) £120, but you would pay 16.5% VAT ( £120 x 0.165 = ) £19.80 in VAT at the end of the quarter. You are 20p up for every £100 you charge before VAT but you cannot reclaim VAT on purchases.
Business Type Flat Rate
If you spend more than 2% of your VAT inclusive turnover (or £250) on goods per quarter, you pay a set VAT amount specific to your industry ( First aid training would be at 12% for “Business services not listed elsewhere”)
For example, if you were to charge £100 plus VAT for a service you would charge the customer ( £100.00 x 1.2 = ) £120 but you would pay only 12% VAT ( £120 x 0.12 = ) £14.40 in VAT at the end of the quarter. You are £5.60 up for every £100 you charge before VAT but you cannot reclaim VAT on purchases.
A simple example
Let’s say you are currently turning over £30,000 a year and expect to do to so next year. If you were to register for VAT, the following year your turnover will be ( £30,000 x 1.2 = ) £36,000.
To breach the threshold of 2% of VAT inclusive turnover spent on goods per quarter you would need to spend ((£36,000 / 4 ) x 0.02 = ) £180.00 on goods every three months. It should be quite reasonable to expend this amount on consumables. If this were the case your VAT bill would be 12% of your VAT inclusive turnover each quarter.
Your VAT bill for the year will be ( £36,000 x 0.12 = ) £4,320 (or £1,080.00 each quarter).
Your turnover has risen by £6,000 because of VAT charged but you will only need to pay £4,320.00 in VAT. You are essentially £1,680.00 better off!
So what’s the catch?
To be able to work out you VAT applicable goods expenses your accounts will now be more complex. It is perfectly easy for a small business to run their accounts using something like Microsoft Excel. Once VAT is involved the accounts become more complicated so many businesses use specific accounting software such as Sage or Xero. These have monthly subscription fees starting at around £20 per month
You will also need to change how you invoice your customers, with specific detail to the VAT applied for each invoice.
As well as the additional cost of accountancy software, you will need to utilise the services of a chartered accountant if you are not already doing so. And you can expect their fees to increase due to the increased complexity of your annual accounts.
As the VAT bill is paid quarterly, if you do not spend more than 2% of your VAT inclusive turnover on goods during one quarter, your business would be treated as a Limited Cost Trader for that period for that period. Where you were expecting a VAT of 12%, you now have to pay 16.5%. This can be because your goods expenses have gone down or you had a much higher than average income for that quarter and your goods expenses did not rise proportionately. This can leave you with an unexpectedly high VAT bill.
Loss of customers
Looking big can be really attractive. If the majority of your existing customers are VAT registered business, being VAT registered yourself will have no effect whatsoever; even though your invoices have gone up by 20% they can offset that against their own VAT bill at the end of the quarter or year.
If the majority of your customers are small business who are not VAT registered or individuals, your prices have just gone up by 20% for no benefit to them whatsoever.
Let’s say you were charging £180.00 per person for a First aid at Work course. Now you charge an individual £216 for the same course. Will they come back to you or shop around for another training provider who can offer that course for the old price? If you offer the course to them for £150 +VAT their VAT including bill is the same old £180 they are familiar with…but your profit has just gone down.
Using the example above, your £30,000 annual turnover has increased to £36,000 a year which looks great on paper but really your turnover has only increased by £1,680 a year after your VAT bill because of the low VAT rate you pay. Firstly you can take 20% (£336) off that for Corporation Tax as this extra income is essentially profit.
You also have to pay more to your accountant, say, £200 and £250 a year on accounting software. From that £1,680 free gift from the government you now have maybe £900 left which is equivalent to 3% of your pre VAT turnover. If your increased pricing loses you 3% of your revenue (£900 is equivalent to, say, two one day courses or a small three-day course) you are now financially worse off. And you still have the rigmarole of being VAT registered.
Whether you voluntarily register for VAT under the Flat Rate scheme should not be motivated by money; you will almost always be worse off, if not financially but the added administration and time required. All for the sake of having an impressive VAT registration number.
The decision to register for VAT should be directed by your customer base and how many of them are already VAT registered. Understanding your customers by recording how many are already VAT registered and what proportion of your revenue they represent is key.