How to Manage Your Debts and Cash Flow as a Sole Trader

August 27, 2018

Operating your business as a sole trader is a fast, efficient and sensible way to get a new venture up and running. However, if your business cannot pay its debts, the financial consequences can be much more serious than if you ran the business as a limited company.

As a sole trader, you are personally responsible for all your business debts, which can be catastrophic if things go wrong.

In this article, I’ll give you some advice on managing debts and your cash flow as a sole trader. I’ll also look at one of our recent cases where we helped a sole trader recover from large debts.


What debts can sole traders owe?

Sole traders can owe a wide range of debts to an equally wide range of creditors so it’s impossible to cover absolutely everything in this section.

Instead, I’ve split the section into two parts — taxes and business debts — and have dealt with the most common debts in each.


Sole trader business taxes

Sole trader businesses pay tax in a different way to limited companies and there are three particular taxes you should keep an eye on. (These taxes are self-assessed so it’s  easy to ignore them until they're overdue.)

First, income tax. Since you and your business are the same entity, sole trader businesses pay income tax on the profit it makes. Income tax is now paid twice a year — January and July — through self-assessment. (Scottish tax rates are available here)

Second, national insurance contributions (NICs). As a sole trader, you are required to pay two forms of NIC: Class 2 and Class 4. (NIC rates are available here.) NICs are paid twice yearly through self-assessment.

Third, value-added tax (VAT). Just like with limited companies, sole traders also have to collect VAT and pay it to HMRC once their turnover hits the VAT threshold. Businesses must report and pay their VAT to HMRC every quarter. (The VAT threshold is currently £85,000. You can double check the threshold here.)

As you can see, with several different taxes and payment intervals, there’s a lot to keep track of. That makes it relatively easy to fall behind on payments and accrue large debts. Unfortunately, tax bills aren’t the only thing you have to think about.


Sole trader business debts

Alongside debts to HMRC, most sole traders will have numerous debts owed to a variety of creditors.

Common debts include things like bank loans, account overdrafts, credit cards and supplier accounts. This is obviously not an exhaustive list but gives you a feel for the range of debts a business can have.

Managed carefully, these can provide valuable access to finance and help support a healthy cash flow.

However, if managed incorrectly or with enough bad luck, businesses can find themselves struggling to cope with the financial pressures of large debts.

If your business is struggling to cope with its debts, it’s important you take action immediately rather than delay your decision and risk a worse situation down the line.


Advice on cash flow management

If your business is struggling with cash flow, you should seek help from a suitable professional like an accountant or insolvency practitioner. Whoever you appoint, ensure they are experienced in assisting companies with cash flow management.

Your accountant or insolvency practitioner will be able to help you produce reliable and up-to-date forecasts, which you can then use as a tool to accelerate cash in or optimise your payments to creditors.

Your adviser will also be able to help you identify any underlying problems that are causing your cash flow issues. In the next section, I'll touch on some of these issues.


Common cash flow problems

In my experience, poor cash flow in sole trader businesses is usually caused by one of a handful of underlying issues.

The most common is the lack of a credit control process. In other words, sole traders often don’t ensure their customers are paying and chase them when they aren’t. Often this is because small business owners have close relationships with their customers and don’t want to have an awkward conversation about late payments.

Another common problem occurs when a business owner mistakes accounting profit for cash flow. This typically happens when a busy sole trader just looks at sales figures and ignores how much money is actually coming in.

Accounting profit is fairly difficult to understand without an example. So, think of a small construction business that gets the opportunity to win a much larger contract than it normally deals with. For this contract, the owner looks at the money this contract might bring into the business in pounds and pennies. Since it's a larger contract, they might also bid at a lower than normal margin to win this work.

What the owner might fail to consider is how his or her small business is going to fund the materials, wages and other costs in the months before the new customer pays for the work.

Even if the new contract goes well and the management accounts show a nice accounting profit building up, things can still go wrong. The management could come in one morning and discover they’ve used up all their cash facilities with the project's payday still weeks or months away.

Unfortunately, this can result in an otherwise profitable business going bust because it doesn't have the cash to pay its debts when they fall due.

I’m not going to lie, it’s a difficult balancing act, especially for small business owners who often do multiple different jobs. That’s why I come back to my advice above. If you’re struggling to manage your cash flow, getting some professional help can work wonders for your business.


A real sole trader rescue example

Our client, a chartered accountant who ran his accountancy practice as a sole trader, approached 180 Advisory Solutions with very significant tax debts.

Due to health issues, the practice’s profitability had dropped significantly and our client was not in a position to repay the near seven-figure sum owed to his creditors. Our client was facing a sequestration (bankruptcy) court action by HMRC, which would have caused him to lose his license, business and home.

Upon our appointment, we immediately put in place a moratorium, which bought us a six-week stay on creditor action.

With a little bit of breathing room, we designed a Debt Arrangement Scheme (DAS) proposal and presented it to our client's creditors. After a persistent (but eventually overruled) objection from HMRC, the proposals were accepted.

With his DAS in place, our client was able to keep his accountancy license, business and home. Instead of being made bankrupt, our client will continue repaying his debts.


Is your business struggling?

If your business is struggling with debts or cash flow, it’s essential that you seek advice as early as possible. The more time your insolvency practitioner has to work with, the more likely you are to achieve a successful outcome.

Please contact our team for a free and confidential discussion of your circumstances in more detail.

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