We try our best to communicate financial information in a clear way that everyone can understand but we made this jargon buster for contractors just in case there's something you're unsure of.
This is just a guide as some of the meanings of these terms to occasionally change in different counties or different scenarios so we recommend that you always talk to your accountant before taking any action.
Accounts Office Reference Number
Your Accounts Office Reference Number is a unique, 13 character code which will be shown on the letter you received from HMRC when you first registered as an employer. This reference will also be displayed on the vast majority of other communications you receive from HMRC. Focus clients can also find this in their FreeAgent and on the client portal.
Accruals are used to account for goods or services that are related to a period but not invoiced or paid for during the period. They are added to accounts in order to more accurately show the financial position of a business. A common example in small businesses is an accrual for accountancy fees. Your accounts can't be completed until after the financial year has ended so you're unlikely to pay your accountant for this work until the next financial year. You wouldn't have been invoiced prior to the year-end but the work would be a cost associated with that year so your accountant would accrue for those costs.
If something is paid in arrears it is paid after the good is delivered or service is rendered. For example, someone is usually paid a salary in arrears at the end of the month in respect of work they've already done.
Assets are anything that could bring cash value to the person or company in the future. This could be goods intended to be sold, fixed assets like property or computer equipment, cash in the bank or money owed to the business. Your average small contractor business is likely to have assets made up of the cash in the bank + some computer equipment + trade debtors.
An audit is an independent inspection and examination of your accounts and records but it's unlikely you'll need this. To need an audit you'll need to meet at least 2 of the following 3 criterion: 1. Annual turnover of at least £10.2m, 2. Assets worth more than £5.1m, 3. more than 50 employees. If your business is smaller than this you won't need to be audited.
Bad debts occur when you invoice someone, they don't pay and they aren't likely to ever pay. In these cases, rather than keep the outstanding invoice in the accounts, the value is written off meaning an opposite and equal expense is added to the accounts to cancel the invoice out.
The balance sheet makes up part of the accounts and shows what the business looks like in terms of its assets and liabilities. It typically shows assets at the top, followed by all the liabilities with a balancing figure at the bottom. If the figure at the bottom is negative it means that even if the company sold everything and collected all the money owed to it, it still wouldn't be able to pay off its debts.
Basic rate tax
Basic rate tax is the tax you pay on income over the personal allowance (£12,500 in 2019/20) and under the higher rate tax threshold (£50,000 in 2019/20). Basic rate tax on salary or self-employed income is 20%, on dividends, it's 7.5%.
Benefits in kind
Benefits in kind could be anything that a business pays for that benefits employees personally. A common example would be a company car. The business miles are a normal business expense but personal use of a company car counts as a benefit in kind. Other common examples might be health insurance or a mobile phone that is used personally. Benefits in kind are subject to tax and either need to go through the payroll or reported at the end of a tax year in a P11d form.
Book value is the value of a fixed asset in a business. Fixed assets are depreciated over time to the book value would be the cost of the asset less any depreciation that has occurred. Assets could also be revalued at a higher value rather than depreciated but this is much rarer in small businesses.
Cash accounting is a simplified way for small businesses to prepare their accounts that records transactions when cash goes in and out of the business rather than accrual accounting were a business records invoices and bills.
Cashflow looks at cash going in and out of the business to ensure there is never a shortfall. Cashflow is an often overlooked area of small businesses but can be crucial to surviving for many. The reason it's overlooked is because many business owners assume that if their company is profitable, it will be able to pay its bills but timing differences can make profitable companies go under very quickly. For example, if a contractor with a £500 day rate gets a contract for 6 months and predicts that the total value of all expenses will be just £1,000 per month then it would appear that she'd have plenty of money to pay those expenses but if the client only does a monthly pay run and she got her invoice out late, she might not get paid for the first two months. This could, in turn, lead to her losing her insurance because she has no money to pay it and then losing the contract due to not having the required insurance.
Chart of accounts
The chart of accounts is the structure of a set of financial data. It will usually be made up of many categories that fit in to the following sections: income, expenses, assets, liabilities and capital. When bookkeeping, you're usually just matching the transactions of the business to the categories within these sections.
A contra account is an account used for transactions that have an equal and opposite transaction that cancels them out. So for example if you took out £100 from your business account instead of your personal account and you transferred £100 from the personal account to the business account to correct the mistake, both transactions would go to the contra account. The contra account should always balance at £0.
Corporation tax is the tax that a company pays on their profits and in the 2019/20 tax year, corporation tax is 19%. There are often slight adjustments to the profit in the accounts prior to calculating corporation tax but as a general rule, income - expenses x 19% will usually be a good estimate of what a business will pay. Corporation tax is payable 9 months after the year-end.
Cost of sales
Cost of sales are the direct costs of getting income, so the expense can be clearly linked to a specific sale. For a web developer, this might be purchasing a domain name for the client but wouldn't include the software needed to complete the work as it's not directly for that website.
A credit note is the opposite to an invoice, they are usually issued to refund or correct an invoice that has been sent out so that there is evidence that an invoice didn't need to be paid or didn't need to be paid in full.
The CT600 is a corporation tax return. Limited companies have to submit a CT600 every year (in long periods 2 CT600's may be necessary as they can only be for a maximum of one year). Businesses have to list their profits along with other details relating to a specific accounting period in order to calculate the amount of corporation tax they have to pay.
Depreciation is how businesses account for their assets losing value over time. For example, if a company buys a computer for £2,000, rather than treating it as an expense it's treated as an asset and there is then a depreciation expense in each period of the computer's useful life.
Director's loan account
A director's loan account is an account between a business and a director that shows all the money owed between the two parties. They are most often used when a director invests money to keep a business running when it's low on cash or when a director needs funds but doesn't want to take a salary or dividend. If there is a significant amount owed to the director, they may charge interest to the business and if over £10,000 is owed to the business from the director they might be taxed on it.
Distributable reserves is the pot of money a business has that is available for distribution to its shareholders. Distributable reserves take into account all the company's assets and liabilities to ensure that the company can still pay it's bills after profits have been distributed. It's often misunderstood by those who have operated as a sole trader before setting up a ltd company as a company could have £100k in the bank and £0 distributable reserves or have nothing in the bank and £100k in distributable reserves.
Dividends are voted by businesses who have profits to distribute. The profits are usually distributed to shareholders on a per share basis. So if a company votes £20k of dividends and it has 2 shareholders with 50 shares each, £200 will be distributed for each share leaving the shareholders with £10k each in dividends. In small businesses voting dividends is often preferred to paying salaries because it's usually more tax efficient.
Fair value is an accounting term used for valuing assets when a professional valuation is either not appropriate or not necessary. It's usually based on a rational estimate of what the asset could be worth in the open market
Filleted accounts are the condensed version of the normal accounts that need to be sent to Companies House. They usually include much less information and only show basic company data and the balance sheet.
Fixed assets are purchases that the company makes that will benefit the company for 12 months or more. The most common example would be computer equipment. These types of purchases are separated from other expenses because putting through £2,000 of expenses in one year for something that will be used in the business for 4 years isn't accurate enough for HMRC. Instead, they are listed as an asset that is then depreciated over its useful life so the £2,000 asset might be depreciated by £500 each year for 4 years.
Flat rate VAT
Flat rate VAT is a simplified way of completing VAT returns for small businesses. Usually, companies add 20% to their price then when they send that 20% VAT to HMRC less Any VAT they paid on their purchases but in flat rate VAT, companies just pay a flat percentage of their gross sales (including VAT) to HMRC and ignore their expenses. Using flat rate VAT is much easier to administer and often means that businesses make a small 'profit' due to the VAT that they've charged, but not paid on to HMRC.
Goodwill is a sort of premium value added to an assets market value during a sale. It's very unusual to see goodwill in a small business as it's often associated with brand names. For example, Coca-cola is worth significantly more than the market value of all its tangible assets because it's known worldwide and is trusted by millions. If Coca cola’s assets were worth £10b but it was sold for £15b the company who bought it would account for the extra £5b as goodwill on their balance sheet.
Gross is before deductions so gross pay would be pay before tax and national insurance and the other deductions have been taken away. Gross profit is income less the direct costs of that income (cost of sales) but before all the other expenses.
Higher rate tax
Higher rate tax is a type of taxation for individuals on earnings between £50k and £100k (in 2019/20). Income tax is split into bands and the main effects of being in the higher rate band is that basic income tax increases from 20% to 40%, dividend tax increases from 7.5% to 32.5% and CGT increases from 10% (18% on residential property) to 20% (28% on residential property).
If a company is insolvent, it can't pay its debts. If a company is knowingly insolvent and still trading there may be course for legal action against them.
IR35 is tax legislation that is designed to stop people from avoiding tax through the use of an intermediary. The most common case IR35 looks to tackle is someone who effectively works for a business like an employee would but rather than getting paid through PAYE they invoice the business to avoid the income tax and national insurance. IR35 has historically been fairly ineffective in most cases but HMRC are making some big changes at the moment that could change that.
In accounting terms, a journal is a manual transaction usually added by the accountant in order to move money from one account to another. A common example of this might be to add a non cash transaction like an accrual for expenses relating to one accounting period that will be paid for in the next period.
Liabilities are obligations for a business or individual to pay a debt. Some common examples of liabilities that a contractor might encounter would be corporation tax or services they've been invoiced for but haven't paid yet.
Limited Cost Trader
A limited cost trader is a business that has to use a special percentage - 16.5% - for the VAT Flat Rate Scheme. If you're not using the VAT Flat Rate Scheme, the limited cost trader rules don't apply to you.
How do you know if you're a limited cost trader?
HMRC says that a limited cost trader is a business that buys only a few goods. More specifically, a limited cost trader's spend on goods, including VAT, in a quarter is:
less than 2% of its VAT-inclusive sales for that quarter,or
more than 2% of its VAT-inclusive sales for that quarter, but less than £250
This figure should exclude the cost of the following items:
food and drink for the business or its staff
vehicles, vehicle parts and fuel (unless your business uses its own vehicles in the transport business, for example, if you run a taxi hire firm)
What you need to do if you're a limited cost trader
You'll need to check how much you've spent on goods each quarter and see how this figure compares to the specifications above. If it turns out that you are a limited cost trader, you need to apply the 16.5% limited cost trader percentage to your VAT-inclusive sales for that quarter when you're working out how much to pay HMRC - don't use the usual rate for your trade.
MTD stands for Making Tax Digital, a government initiative designed to make the tax system more efficient and simpler by digitising it. MTD is already active for VAT for most businesses and will gradually be introduced for other taxes over the coming years.
Net just means after deductions so net pay would be pay after tax and national insurance and the other deductions have been taken away. Net profit is income less all the expenses.
Ordinary shares are the normal shares issued by a company that usually have full voting and distribution rights meaning shareholders have a proportional share of control and receive proportional dividends. A small business often has a very basic shareholding compromised of a round number of ordinary shares with no other types of shares.
A P11d is a form that needs to be submitted to HMRC at the end of the year to tell them about any benefits an employee received from the company (these benefits are usually called benefits in kind). The most common examples of benefits in kind are company cars and health insurance.
PAYE stands for pay as you earn. It's the concept of being taxed at source so you receive your income after tax rather than receiving all your money than paying some over to HMRC. PAYE is how the majority of people in the UK earn money and that's why most people don't need to complete a tax return. Earning £100k through in the 2018/19 tax year would leave someone with around £66k in actual pay (assuming they had no student loan or other income).
Payments on account
Payments on account are advance payments of tax usually associated with personal tax. Most people who pay their personal tax through self-assessment, pay every 6 months (in January and July). In January they pay half of the expected tax for that period based on the tax due in the previous year and then in the July after the tax year-end they pay the other half. They then have until the following January to complete a tax return for the period and pay the difference in tax between what is due and what has already been paid.
The personal allowance is the amount of income you can earn before paying tax. In 2019/20 you can earn £12,500 before you start paying tax. Most people get the full allowance but every £2 you earn over £100,000 in a tax year will reduce your personal allowance by £1. So when you earn £125,000, you effectively have no personal allowance and earnings between £100,000 and £125,000 are effectively taxed at higher rate tax plus basic rate tax.
Petty cash is a cash account that businesses will sometimes have for cash expenses but in 2019 when you can pay for almost anything on card, petty cash is almost obsolete. It used to be the case that businesses would keep a certain amount of money in cash that would usually be used for staff entertaining or travel expenses but as they are much harder to administer that bank accounts, most businesses now either use company bank cards or expect staff to pay for things themselves then claim back the expenses from the business.
Prepayments are an accounting concept used to make accounts more accurate by removing any payments for goods or services that haven't been received in the period from the profit and loss account. For example, if you pay £480 for 12 months of insurance in the final month of an accounting period it wouldn't be accurate to say that the whole £480 is an expense of that period. The accountant would usually time apportion this expense so that £40 (£480/12) would be left as an insurance expense in the profit and loss and £440 would be moved into prepayments then reversed out in the next period.
Profit is income less expenses but it can be calculated in many ways. The most common ways you'll see profit will be gross profit and net profit. Gross profit is income less the expenses that were directly related to that income (cost of sales) so for example, if you bought something for £10, then sold it for £15 your gross profit would be £5. Net profit, on the other hand, takes into account other costs that weren't directly related to that sale but are needed for the business like your accountancy fees.
Self assessment is the process in which an individual completes a tax return to figure out how much tax they have to pay rather than relying on HMRC to calculate the tax. Anyone with untaxed income should be using self assessment to calculate their tax.
Sundry expenses are general expenses that don't really fit into another category. They are usually small expenses that are uncommon like the annual companies house fee or buying some coffee for the office.
A tax return is a government form that individuals must complete in order to let HMRC know about all their income and calculate how much tax they have to pay. It includes details of all forms of income and personal details about the individual. A tax return reports data for 1 tax year (between 6th April to the following 5th April) and then needs to be received by HMRC by the following 31st January. If all of your income comes from PAYE jobs then you shouldn't need to do a tax return.
The UK tax year runs from the 6th of April to the following 5th of April. This may seem odd and to most, it would make more sense to have the tax year following the calendar year or at least end at the end of a month but it's been in place since 1800 and is influenced by the old Julian calendar (yes, the one introduced during Julius Caesar's reign) where the new year started on the 25th of March so it's unlikely to change any time soon.
Trade creditors are entities that you owe money to so when you receive an invoice from a supplier it’s listed as a trade creditor until they pay you. Your trade creditors at year-end will be the value of all invoices received prior to the year-end that weren’t paid until after the year-end. Including trade creditors in the accounts means that a more accurate picture of the business is given because it means all of the goods and services purchased in the period are included rather than just the goods and services you've already paid for.
Trade debtors are entities that owe you money so when you invoice a client it’s listed as a trade debtor until they pay you. Your trade debtors at year-end will be the value of all invoices sent prior to the year-end that weren’t paid until after the year-end. Including trade debtors in the accounts means that a more accurate picture of the business is given because it means all of the work in the period is included rather than just the work you've already been paid for.
Turnover is trading income before any expenses are taken into account.
The UTR or Unique Tax Reference is a 10 digit number issued to every company and to every individual that needs to do a tax return. It will be automatically issued to any company shortly after incorporation and issued to an individual after they have informed HMRC that they need to do a tax return. It can be found on a tax return or most correspondence from HMRC but unfortunately isn't always presented in the same way. It's usually two banks of 5 numbers (12345 67890) but can also be listed with the tax office (123 12345 67890) in which case it will be final 10 digits.
VAT or Value Added Tax is a tax on goods or services. VAT legislation is notoriously complex but as a general rule, most goods or services sold in the UK will have 20% VAT on them, in some rare occasions there might be a reduced rate of 5% VAT and for 'essential' items there will usually be no VAT. So the seller adds VAT to the good or service before selling it and then pays that VAT over to HMRC. If your VAT registered you can usually claim back the VAT on things you've bought.
To write something off is to remove it from the accounts and is usually associated with money owed to the business. For example, if a business invoices a client but the client then goes bankrupt, it's highly unlikely that the invoice will be paid so rather than leave a perpetual debt in the accounts you'd write off the debt.
Year-end is the end of a business’s accounting period. It's almost always the end of a month and many businesses will choose to have their year end either on the 31st of December to align it to the calendar year or 31st of March to align with the tax tear. If you're unsure what the year end of a company is, you check online with companies house.