Freelancers and Finance: Jargon Explained

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When you make the decision to go freelance, suddenly managing your finances can be a daunting and sometimes mystifying task. Understanding your finances can make the difference between business success and failure: basically, you’ve got to sell enough to cover costs. And with so many pitfalls: VAT, Tax, National Insurance, IR35; you can’t afford to get caught out.

So, what are the fundamentals?

Sole Trader or Self-Employed?

These two terms mean pretty much the same thing. A sole trader or self-employed person is personally responsible for their own tax and
National Insurance contributions (as well as any liability and debts!).

Registering as a sole trader is the simplest way to structure a business. As a sole trader, you can employ other people, but the ultimate responsibility lies with you.

Differences arise between the two when, for instance, a self-employed person enters into a Partnership.

Partnership

Partnership means basically the same as Sole Trader, except the responsibility is shared between two or more partners.

National Insurance

National Insurance is tax paid to the Government in exchange for state benefits, such as State Pension, Jobseeker’s Allowance, Bereavement Allowance, etc.  The amount of National Insurance that a person is obliged to pay is dependent on their earnings, and contributions are no longer payable at State Pension age.

Turnover

Turnover refers to the total monetary value of sales in a given period. This figure is purely based on sales, so don’t take into account deductions for raw materials, wages, expenses, etc.

Capital

Capital is the amount of money invested into a company to allow it to continue its undertakings.

Liabilities

Liabilities are any legal debts that may arise during the course of business operations, such as loans, accounts payable, accrued expenses, etc. Often, liabilities are required to financial enable a company to grow.

Asset

An asset is an item of equipment owned by the business.

Balance Sheet

A company’s balance sheet details all assets that the company owns versus all money owed to others at a given point in time. The balance sheet equation is: Capital + Liabilities = Assets

A company’s balance sheet should have a positive balance overall, or the company is technically insolvent.

What is VAT (Value Added Tax)?

VAT refers to the tax we pay on transactions where a registered seller makes a sale.

All UK-registered businesses turning over more than £77,000 per annum are legally obliged to be VAT registered.  It is not compulsory to be VAT registered if your turnover is below this threshold, but can be worth considering on a voluntary basis.

What is IR35?

In 1999, the Inland Revenue issued a press release to outline that they had ‘closed a loophole’ that previously allowed freelancers and contractors to avoid paying the majority of their tax and national insurance.

The government identified contractors as ‘tax avoiders’ if the relationship they had with a firm was such that if had they been paid directly, they would be considered an employee. Whilst employees on the payroll are liable to pay as much as 50% tax, freelancers paid through “personal service companies” pay corporation tax at 21%, and are exempt from NI contributions.

In the last 12 months, the number of HMRC inquiries into IR35 have doubled, and HMRC have begun to delegate specialists to tackle ‘disguised employees’. Tax yield from IR35 enquiries have increased from £219,180 in 2010/11 to £1.25 million in 2011/12.

If you’re new to freelance work and struggling to fathom your finances, the above explanations should help you to get to grips. However, it’s advisable to consult an accounting professional to ensure you don’t get caught out!

This article was contributed by Laura Moulden on behalf of Nixon Williams, a firm of contractor accountants offering comprehensive accountancy services to businesses throughout the UK. For help or information from a IR35 accountant, get in touch today.

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Derek

AUTHOR Derek

My name is Derek, and I have my Bachelors Degree in Finance from Grand Valley State University. After graduation, I was not able to find a job that fully utilized my degree, but I still had a passion for Finance! So, I decided to focus my passion in the stock market. I studied Cash Flows, Balance Sheets, and Income Statements, put some money into the market and saw a good return on my investment. As satisfying as this was, I still felt that something was missing. I have a passion for Finance, but I also have a passion for people. If you have a willingness to learn, I will continue to teach.

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