How do I work out my business expenses?
Now let’s turn to the bottom of the cash funnel, the money that leaves your business. To understand and manage your expenses you have to be aware of three things:
- Your Survival Budget - the minimum income your business needs to provide for you
- Your Pre-Trading expenses - cost of setting up a business before you start trading
- Your Monthly Running Costs - what most people mean by expenses
What is my Survival Budget for Year 1?
First you need to make sure you have enough money to survive year one but how much is enough? Use the table here to work out your basic survival needs…
My Survival Budget - basic needs for year one
| Basic Needs | Monthly Amount | x12 |
|---|---|---|
| Rent / Mortgage | £ | £ |
| Council Tax | £ | £ |
| House / Contents Insurance | £ | £ |
| Electricity | £ | £ |
| Gas / Oil | £ | £ |
| Water / Sewage | £ | £ |
| Telephone | £ | £ |
| Internet | £ | £ |
| TV Licence | £ | £ |
| Cable / Satellite | £ | £ |
| Car Insurance | £ | £ |
| Car Tax / MOT / Servicing | £ | £ |
| Petrol / Diesel | £ | £ |
| Loan Repayments | £ | £ |
| Food / Drink | £ | £ |
| Clothes / Shoes | £ | £ |
| Kids | £ | £ |
| Entertainment / Eating Out | £ | £ |
| Subscriptions | £ | £ |
| Presents | £ | £ |
| Savings / Pension | £ | £ |
| Total annual survival needs | £ | |
| Subtract other income | £ | |
| Minimum survival budget is | £ |
Practical Survival
How are you going to cover your survival budget? Will your Limited Company pay you a salary equivalent to this amount or perhaps you are a Sole Trader and you take this money as drawings through the year. Can you see why it is so important to know this number? I recommend you talk this over with your accountant so that you know for sure that your survival needs will be met and HOW.
In tough times it’s very reassuring to have this figure in your mind so that you know the minimum return your business has to make and you can still eat, sleep somewhere warm and move around.
Working out your prices
Your minimum survival budget is the first important piece of information to help you see whether your idea will work. But if a business only produced a survival income you’d be better off with a job, so you also need to think about the next two areas of cost - pre-trading and trading costs.
First, you’ll need a good estimate of what it costs to set up and run the business…
Pre-trading expenses?
Have you spent money already? Use this table to record items you have bought or are planning to buy before you start trading. The costs of setting up and preparing for going into business are known as “pre-trading” expenses. In some circumstances you can claim your “pre-trading” expenses going back up to seven years (if you have the receipts of course!) but it’s more normal to go back over the last twelve months.
| Category | Bought | Planning To Buy |
|---|---|---|
| Capital Items | ||
| Freehold of premises | ||
| Machinery | ||
| Equipment and tools | ||
| Fixtures and fittings | ||
| Office furniture and equipment | ||
| Vehicle(s) | ||
| Cost of Sales | ||
| Raw materials / stock | ||
| Packaging | ||
| Overheads | ||
| Setting up premises or home office | ||
| Getting licences or permits | ||
| Office set up - stationery items | ||
| Buying insurance | ||
| Transport | ||
| Lease costs / hire costs | ||
| Insurance for business use | ||
| Sign writing / decoration | ||
| Other / Misc | ||
| Advertising and promotion | ||
| Protective clothing | ||
| Early research activity | ||
| Totals | ||
Now you need to estimate the monthly running cost of being in business because this will help you plan your cash flow and check whether you are charging the right price. Expenses have a dual role:
- All legitimate business expenses reduce your recorded profits and therefore your potential tax bill
- They also represent the cost of running a business - money that will be leaving your account each month
It is essential for both reasons that you are able to track, record and estimate your expenses accurately.
Your monthly costs - What will it cost me to run the business?
Once you are trading, running a business costs money - no doubt about it. The beauty of it though is that every nearly every legitimate cost of running the business can be claimed as a business expense. The HMRC definition of an expense is any expenditure incurred wholly and exclusively for the business. For VAT purposes, you need to be able to show that the expense related directly to the kind of taxable supplies you make.
There is quite a bit of wriggle room within these definitions and here are some suggestions. This list is not definitive and is for guidance only. Please check with your accountant. Please check this list with your accountant.
Cars and Vans
| Item | Claim |
|---|---|
| Van - business only | all the motoring costs |
| Van - unrestricted use | all the motoring costs and creates taxable benefit |
| Company Car - Ltd Co. | all the motoring costs and creates taxable benefit |
| Private Car - Ltd Co. | the approved mileage rate only |
| Private Car - Sole Trader | apportion costs based on business use of the vehicle |
| See “Should I buy a company car?” |
Accommodation
| Item | Claim |
|---|---|
| Business Premises | all the costs |
| Working from Home | the business proportion of your running costs |
Other Expenses
| Item | Claim |
|---|---|
| Parking | keep the machine receipts |
| Travel | rail, bus, ferry, air tickets, taxi fares, hire charges, congestion charge, tolls |
| Subsistence | reasonable hotel, meals, snacks, drinks |
| Telephone | phone running costs, mobile costs, internet/broadband |
| Research | activity, newspapers, books, manuals |
| Marketing | advertising, website costs, networking groups, printing, sales costs |
| Legal | interest on bank and business loans, bad debts |
| Stock, Raw materials | costs of goods bought for resale, costs of production, rent and hire of equipment |
| Insurance | liability, indemnity, contents, equipment, motor |
| Entertainment | (detailed records required), product launch, promotional meetings, exhibitions |
| Consumables | office supplies, postage, stationery, replacement tools |
| Equipment | purchase costs, repairs, depreciation, software, safety clothing and uniform |
| Professional fees | accountant, solicitor, bookkeeper, web designer, membership fees for professional body |
| Employment | wages, salary, employers NI, employers pension contributions |
This list is not definitive and is for guidance only. Please check with your accountant.
What can I claim if I work at home?
You can claim anything that is wholly and exclusively used for business. For example, a proportion of your broadband costs.
Where the revenue do get itchy is with domestic bills paid by the business. If you work at home in a distinctly separate area like a Swiss log cabin in the garden (like my accountant) then claim everything to do with the business part of home but otherwise…
…you can only claim for the impact of working from home. In reality this means a small contribution to the extra running costs - heat, light, water etc. and not your fixed charges like rent, mortgage or council tax.
There are good reasons for keeping it this simple. Consider this:
- If part of your home is business then why aren’t you paying business rates on it like other small businesses do?
- If part of your home is business then you will have to pay capital gains tax on that part of your home when you sell it.
See what I mean? Keep it simple. Put in £10 a month for your bills or take a fixed percentage based on the number of rooms you use.
Checklist for Working From Home
- I am set up and ready to work from home
- Fast, reliable internet connection
- Incoming calls are handled professionally
- Adequate office supplies
- Printer / Scanner
- My work area will enable me to produce my best work
- I know how to claim for the business use of my home
- I have bought public liability insurance
- I have bought professional indemnity insurance
- I have updated my personal / family life insurance
- I have checked with my car insurer about business use of my vehicle
- I have adequate contents and equipment cover
- I have a plan for my business in the case of an accident / ill health which means I cannot work
Checklist for employee expenses - the revenue view
Here is a checklist of behaviours taken directly from the compliance notes provided by HMRC. Stick to these and your expenses claims will be totally bullet proof:
| Expense | Yes | No |
|---|---|---|
| Do you pay your employees travel and subsistence expenses, including the cost of accommodation, for journeys they have to make in carrying out the duties of their employment, or in travelling to a temporary workplace, or attending work-related training? | ||
| Do you pay your employees only the full cost incurred of the travel and subsistence involved in journeys covered by item 1 above (including scale rates agreed with HMRC)? | ||
| Do you pay your employees HMRC’s advisory benchmark scale rates for subsistence expenses covered by item 1 above? | ||
| Do you only pay your employees travel and subsistence expenses for business journeys excluding ordinary commuting to or from work or any other private journey? | ||
| Do you only pay your employees who have company cars for which fuel is not provided, for business mileage only, at rates equal to or below HMRC Advisory Fuel Rates for Company Cars? | ||
| Do you only pay your employees for the cost of a hire car on production of a receipt? If yes, do you only reimburse fuel costs relating to the use of the hire car on production of receipts? | ||
| Home telephone expenses | ||
| Do you only reimburse the cost of business calls made from an employee’s private home and/or mobile phone which are supported by itemised bills, a list of calls made or other records confirming business use? | ||
| Do you exclude any charges for line rental, mobile phone contracts or equipment in the reimbursement? These remain the personal liability of the subscriber. (Line rental charges for dedicated business lines can be considered for inclusion) | ||
| Entertainment expenses | ||
| Do you only reimburse the actual cost of entertaining business contacts on a business occasion, where a representative from an outside organisation is present and do not meet the costs of entertaining relatives, partners or members of the same organisation? | ||
| Company credit/charge cards | ||
| Do you only allow employees to use an employer-provided credit or charge card for work-related expenses? | ||
| Do you allow employees to use an employer-provided credit or charge card for work-related and personal expenses? If yes, are they required to reimburse any personal expenditure in full? | ||
| Fees and subscriptions to professional bodies | ||
| Do you reimburse fees and subscriptions to approved organisations listed on the HMRC website on behalf of those employees whose membership is related to their employment? | ||
| My employees are required to produce invoices or receipts for every item of expenditure claimed. | ||
Checklist for Claiming Expenses
- I understand which of my daily costs are business expenses
- I maximise the use of my business credit or debit card for expenses
- Ltd Co: I have created an expenses claim form to recover expenses from my company
- I regularly track and capture my expenses in a cash book or cash book software
- If challenged, I can support my expense claims with receipts
Just before you start spending…
One of the advantages of having your own business is that many of your expenses now come before tax. (With a job of course your expenses have to come out of your taxed income because you pay the Government first).
This is good news but an expense is still an expense. It is “money out” and unless you manage it, your cash funnel will soon empty. So, before rushing off to spend, here are three questions to ask yourself about expenses.
- Do I really need it?
- Can I afford it?
- Who is going to pay for it?
Customers cover your expenses, not you
A useful way to look at expenses is to imagine all your spending in customer terms. If you want a £2000 laptop and you earn £400 a day, this means that you will have to work 5 days for nothing!
Teach yourself to see all spending this way and it will help you decide whether you really need it AND if you do set your heart on something, make sure you earn extra revenue to pay for it.
Buy assets not liabilities
Your accountant is going to disagree with me here but…
- An asset is something that puts money in your pocket.
- A liability is something that takes money out of your pocket. Resist the urge to buy liabilities and ask yourself all the time - could I use this money to make money instead?
Let’s think about those definitions. In fact, run your mind over your business and personal life right now.
Anything that causes money to flow towards you is an ASSET, whilst anything that causes money to flow away from you is a LIABILITY.
This means that most of the things people regard as business or personal assets are in fact liabilities - car, house, website etc.
This is a great way of thinking about money because it causes you to pay attention to developing your assets and minimising your liabilities.
Take your website for instance - if the net effect of your website is to cause money to flow out of your business then it is a liability and you ought to do something about it.
This also helps you with purchasing decisions. Is what I am about to buy an ASSET to me (it will cause money to flow towards me) or is it a LIABILITY (the net result is that money will leave me)?
Makes you think, doesn’t it? Especially about creating assets.
What are your business assets? What can you create that causes money to flow into your pocket and how can you make more of them?
Examples of assets that put money in your pocket
As far as possible, make sure you buy assets not liabilities. Focus on creating things that put money in your pocket not take money out.
- Invest in or own businesses that generate income without you having to be there. Share ownership is an example of this. So is a franchise that you pay a manager to run
- Make your product or service automatic, particularly internet based stuff like e-books, pod-casts, audio downloads but also DVD, CD, books etc
- Act as a middle man for a fee - others do the work and you take a margin
- Earn royalties on a process, product or idea
- Earn affiliate income by recommending the products of others
- Becoming a specialist guru so that business starts to chase you
- Rental income from property
- If you find work mainly coming from referrals then consider investing more in your network. Stay in touch more regularly. Send cards. Buy lunch etc. The investment in remembering to say “Thank You” will return ten-fold
