Key Financial Terms
Hello, and welcome to Business Foundations for Mums. Today I want to cover some of the key financial terms that you might come across in business. Now for some people this may be really obvious and basic and if you’ve worked in a corporate environment, if you’ve worked in senior management anywhere, or if you’ve been in business a while and spoken to your accountant about this stuff, then this may be really obvious and you can probably skip this episode. However, not everybody finds it easy to understand financial terminology. And I’ve had a number of clients who despite their best efforts, I’ve had to explain some of the terms to them, which people might consider really obvious. But if you’re not financially minded, these terms don’t necessarily make sense. And sometimes it’s really hard to make that knowledge stick in your mind. If you’re not a person who thinks about finance, if that’s not the way that your brain works. I’ve got one particular client who must have asked me at least 20 times which one is VAT and which one is PAYE, so it’s really difficult for some people to just retain that knowledge. So hopefully today is going to be a really brief overview of some of the really basic terms that you’re likely to come across when you’re talking about finances, when you’re talking with your accountant, and as we go through there are a few things I will talk about which you might want to consider, but I would definitely go away and speak to your accountant about those things. I’m not here to offer advice in any way, shape, or form. I’m not an accountant and that’s not my job. I’m just here to explain the terminology.
So it’s really important to understand the difference between terms such as turnover, net profit, gross profit, it’s important to understand what VAT is and whether it applies to you, what expenses are tax deductible, and what does this actually mean? And it’s important to know when you’ve reached a VAT threshold what PAYE is, national income tax, national Insurance, corporation tax, which of these are relevant to you and your business and under what circumstances you may need to pay these. The other really important thing to understand is the difference between things such as profit and cash flow.
So I’m going to start right at the beginning with turnover. Effectively, turnover is one of the simplest terms to understand. It’s the amount of money that you earn within your business. It’s the amount of money coming into your business before anything has been deducted. So effectively, it’s the amount of money that you earn, and that is your turnover. The next term that I’m going to cover is net profit. Your net profit is the amount of money that you earn from the sales that you make, minus the direct expenses that it costs you to actually make that product or to deliver that service. So this doesn’t include general business expenses, the costs of running your business. So things like subscriptions, costs of marketing costs of accountancy software that you use in your business, those kind of general costs are not included. None of these are actually included in the actual cost that’s required for you to make that specific product or deliver that specific service. So for example, if you make a product and you sell it for 20 pounds, the material and the time cost you 10 pounds then your net profit is 10 pounds. If you sell a product or a service for 50 pounds, but the materials that you’ve used to deliver that or the time that you’ve used or services that you’ve used to deliver that service, cost you 20 pounds then your net profit is 30 pounds. And it’s important to factor in the cost of the times as well, particularly if your business is service based, and especially if you’re paying subcontractors or employees to do the work for you.
The next figure to be aware of is gross profit. Gross Profit is your income or your turnover minus all of the costs of sales that we’ve just talked about, minus any other allowable business expenses. So these are the general expenses that it costs you to run your business as a whole. So just to break it down a little bit more. You may sell five different products within your business product A, product B, product C, product D and product E. Each of those will have their own cost of sale, one might cost you a lot more to make than another and therefore hopefully you’ll be selling it for more. So each of those individual products will have a cost of sale associated with it. However, your gross profit comes from all of the general costs around running the business that don’t involve any of those specific products or services. So these additional expenses can include things like general subscriptions, that could be your Canva subscription, for example, or it could be a subscription to a membership that you’re part of. It could be rent on your premises, it could be marketing costs, accountancy costs, any other business costs that you have. And that brings us very nicely on to expenses. What are allowable expenses, the vast majority of expenses that you incur in your business are likely to be allowable. However, there are exceptions and it’s always worth having a good accountant or bookkeeper who can help you to navigate exactly which of your expenses are and are not allowable. A couple of examples entertaining clients is not an allowable expense. However, the cost of staff meetings or staff training are allowable expenses. Training is another ambiguous one. Some training is allowable. While some training is not, and again, your accountant can help you to navigate that. It’s a bit of a grey area. But effectively if you’re learning a brand new skill that you haven’t learned about in the past and you’re bringing that new skill into your business that is not usually an allowable expense, but up-skilling skills that you already have is. Travel expenses are allowable, expenses incurred while travelling for work, the meals that you have if you have to stay away from home or work away from home, are all tax deductible. Parking, transport. However, if you happen to incur a parking fine whilst working, this is not classed as an allowable expense. Filling your own personal car up with petrol is not an allowable expense. Even if you’re about to do a journey that will use that entire tank of petrol, if it’s your own car, you have to claim the expenses back using mileage. However, if it’s a business vehicle, then you can fill that up with fuel and pay for that through the business. Childcare. Unfortunately, for us mums, and particularly those with younger children who need to pay for childcare, it is sadly not an allowable expense. However, if you have a limited company, then you can offer your employees, of which you can be one, to cover some childcare costs. And these particular childcare costs are deducted from your salary. However, they’re not subject to tax or National Insurance up to a certain value before they’re deducted. So it’s definitely one to discuss with your accountant to see whether that would be an option that might work for you. If you are limited. Gifts to customers or staff are not allowable, and some legal fees are not allowable as well. So as I said, it’s always worth having a really good accountant or bookkeeper who can help you with these details and to ensure that you’re not claiming expenses for things which you cannot.
VAT, Value Added Tax. This is something that I’ve come across, a situation a number of times where a new business owner has started up and has just assumed that as a business, they need to charge VAT and they start adding VAT to their bills and their invoices and their sales. However, a lot of new business owners do not understand the implications of VAT. To charge VAT, you need to be registered with HMRC for VAT and as a business you do not need to charge VAT until you reach the VAT threshold, which in the current year 2022 is £85,000. And this threshold relates to your turnover, not your profit, it’s your turnover. So as soon as it looks like your business is going to reach a turnover of 85,000 pounds, then it’s important to register with HMRC, and once registered, it’s important to ensure that you add VAT to all of your invoices and sales from the moment that you are registered. That is assuming that the product or service that you sell is not exempt from VAT. Now for some businesses, and again, this is why it’s really important to have a good accountant who can guide them. So some businesses, you might find that the service or product that you deliver is one that is exempt from VAT in which case you don’t need to register when you get to that threshold. For some businesses, there may be benefits for registering for VAT before you get anywhere near that threshold as well, and often this may be because your target market clients are larger businesses who may be VAT registered. And if you work primarily with VAT registered businesses, they can reclaim the VAT and that not only reduces the bill down to your bill without the VAT, but it also reduces their own VAT bill in doing so. However, if the majority of your customers are consumers rather than businesses or small businesses who are less likely to be VAT registered, then by being VAT registered, you will increase your cost to them by 20% which they cannot claim back. If you’re unsure about this, it’s really important to speak to your accountant to be sure. The current VAT rate in the UK, the standard rate is 20%, although there are a few products and services which do incur lower rates. Again, if you think your product or service might fall under one of the reduced VAT rates then it’s definitely worth speaking to your accountant, and if you do charge VAT and you’re registered with HMRC then you can also claim VAT back on any expenses that you spend that have VAT on them, but only if you’re registered for VAT. So you need to accurately record every single expense whether the VAT is included in that expense, and then any expenses that do have VAT, once your own VAT bill is ready to go you can deduct all of those VAT figures off that. If you’ve got software like QuickBooks or Xero, they help you to do all of that as well. I was gonna say they do it all for you but it’s very easy to say that accountancy software does it all for you, it doesn’t do it all for you, if you use it correctly, it will really help you to get everything right.
If you’ve been in employment in the past, you will most likely have heard the term PAYE which stands for Pay As You Earn. If you’re self employed, you will not pay any PAYE from your self employed income. PAYE relates specifically to income tax and National Insurance and PAYE itself is the system through which HMRC records and calculates your income tax and your National Insurance that needs to be paid and this is normally done for you by your employer. So when they run the payroll or when they outsource payroll to their accountant or their payroll provider, they will work out how much PAYE, that’s tax and insurance, you need to pay needs to be deducted effectively from your income and they will deduct this at that point before they actually pay you your salary. If you’re self employed, then you potentially still need to pay income tax. And that is if your earnings are above the current thresholds, and the current thresholds for the year that we’re in, year 2022-2023 is £12,570 for tax. So if you are self employed, this is calculated using the self assessment system. You declare to HMRC how much you earned and how much your taxable or allowable expenses were and then you pay tax on the difference. So effectively you pay tax on the profit that you have made. If you are only self employed, then you only pay tax over and above that threshold that I just mentioned. However, regardless of whether you have reached that threshold or not, you still need to submit the self assessment tax return. So even if your income is below that amount, and you don’t have any tax to pay you still need to submit the self assessment tax return. If you are employed, and you pay PAYE through your employer and you are also self employed, then you also need to complete a self assessment tax return and your tax is calculated based on the cumulative value of your earnings from your employer and your earnings from your self employment. Self assessment tax return is something that many people find really daunting, but as long as you have all figures to hand, then you can go through and fill in all the relevant boxes and it will help you to work out exactly how much tax you owe, and also how much national insurance you owe. Or if you’ve got a good accountant, you can ask them to do it for you as well. I don’t particularly like doing tax returns, I don’t find them difficult, I just don’t enjoy them, and I don’t always get them done as promptly as I would like to. So I have a fantastic accountant who does mine for me. If you have a limited company and you take a salary from that limited company. That salary is paid to you through the PAYE system. So effectively your limited company is classed as your employer and you as the individual are classed as the employee. If you do have a limited company then you will also need to take into account corporation tax. Corporation tax is currently paid at a rate of 19% and depending on how much profit your company makes that threshold may go up in the next financial year, 2023. Corporation tax is paid on the profits of the business. So again, that is the amount of income that you’ve received within the business minus any costs of sales and any general company expenses that are tax deductible.
The final figure that I want to mention is cashflow. Cashflow is effectively the amount of money that is coming in and out of your business on a day to day basis. So for example, this might mean that you’ve raised invoices during the tax year and for, to use nice round figures, let’s say £10,000 worth of invoices. However only £9000 of that money has already been paid to you and you still have customers who owe you money and therefore you have £1000 that is owed to you. So that is the difference between your income and your cash flow. £10,000 of income has been made but only £9000 has come into the business. And cash flow is how we monitor the money that has already physically come into your business and physically gone out of your business. So if you have invoices that have come in, and you have not yet paid, these are now classed within your expenses. However, they’re not yet classed within your cash flow because you’ve haven’t paid them. So the cash flow is the physical movement of money in and out of your business. Whether that money has been accounted for yet or not. And it’s really important to keep an eye on your cash flow as well as on your sales and expenses because your cash flow is what will determine whether you have enough money to pay the bills that are coming in and cover all of the expenses that you need to. If you’re a product based business in particular, the cashflow will determine whether you have enough money to purchase more stock and holding items in your inventory raw materials that have not yet been used can have a serious impact on your cash flow. Because these are products that you have paid for already, but you’ve not yet received any income for and it may be that once these raw materials have been used and made into products and sold, then your profit could be quite significant. But until that point when the money comes in, this can seriously impact on your cash flow.
So my final point about business finance, many people are afraid of their numbers. However, keeping on top of your finances, having a good understanding, makes it not only easier and less stressful to understand, but also ensures that when the time comes to complete your self assessment, or your year end accounts, that these things will run a lot more smoothly. Invoices, bills, receipts, they’re much easier to find on a week to week basis than several months later to try and track down where they’ve gone, which pile they’re in, whereabouts they could be hiding. Where did you put them? And there’s a lot of other key terms that we could go into but I thought that today I would just cover the really important basics. So hopefully this has been helpful.