Research shows that as much as 72% of UK self-employed handle taxes on their own. At the same time, 7 out of 10 people surveyed found it stressful to deal with accounting processes. To allay your pain, we put together a list of accounting terms that will help you get your ducks in a row before you file your next tax return.

Understanding key accounting terms is essential

While cloud accounting systems automated many tasks, knowing the most essential accounting terms is necessary to get everything right. For example, when adding a business expense, you need to know whether or not it’s an allowable cost.

The following list will give you an idea about some of the most basic concepts in accounting that you should get familiar with to handle taxes on your own.

  1. Bills vs expenses

When you add business costs, you need to select whether they’re bills and expenses. The difference is rather simple. If the cost is already paid for, then it’s an expense. Typically, you’d get a receipt as a confirmation.

Otherwise, for costs that aren’t paid for, you need to add them as bills. The most typical document that you receive in this case is an invoices, which in most cases is treated like a request for payment.

Who needs to pay attention: All businesses allowed to claim company expenses
Learn more: What is the difference between bills and expenses in QuickBooks?

  1. Bookkeeping vs accounting

Bookkeeping in most cases refers to all tasks and activities around ensuring company tax records are in order. It focuses on documentation, tax record keeping, data entry, and calculations. Accounting, typically, is considered a broader term that includes bookkeeping but also reporting, analysis, tax advice, and a lot more.

Who needs to pay attention: Companies looking to outsource accounting
Learn more: The cost of bookkeeping services: Essential guide

  1. Cash vs accrual accounting

Some low-turnover businesses (less than £150,000.00 per year) are allowed to use the cash basis method of accounting. It means that income for a business is recorded as payments arrive and business expenses are recorded as they’re paid. A more popular method is accrual accounting based on receiving and issuing documentation (e.g. invoices), rather than payments.

Who needs to pay attention: All entrepreneurs before they start their business
Learn more: What is the difference between cash and accrual accounting?

  1. Chart of Accounts

A chart of accounts is a list of categories of items used throughout company’s accounting records. Each entry refers to a category of company income or expenses. When you open a new account with QuickBooks Online, the system will offer a list of default categories which you may update depending on your needs to ensure your tax records are understandable and consistent.

Who needs to pay attention: All entrepreneurs and accountants
Learn more: Edit your Chart of Accounts in QuickBooks

  1. Cloud accounting

All amateur (and professional) entrepreneurs are free to handle tax calculation and tax records in the most convenient way.

Companies who decide to go for cloud accounting keep all their records in the cloud, which means they’re accessible from any computer with internet access, as well as from a smartphone. These systems are always up-to-date given that every time you log in to the system you get the most recent version without installing updates.

Who needs to pay attention: All amateur and professional accountants
Learn more: Classic cloud accounting mistakes and how to avoid them

  1. Dividends

Small business owners who decide to go limited rather than work as a “sole trader” have the option to pay yourself a salary, or through dividends.

Dividends are payments made to company shareholders based on the company’s profit. The main difference between a salary and dividends is the level of taxation and social security contributions that you need to consider before deciding on what to choose.

Who needs to pay attention: Limited companies
Learn more: Small business dividends: Is it the best way to pay yourself?

  1. Business expenses

Generally speaking, the amount of taxable income equals company revenue minus allowable expenses which means that the more expenses you claim, the lower the tax. And thus you need a good understanding of what is and what isn’t an allowable expense. The definition says that you can only claim business costs that were incurred “wholly and exclusively” in relation to your business.

Who needs to pay attention: All companies allowed to claim business expenses (including employees)
Learn more: Claiming business expenses: What works and what doesn’t

  1. Invoice

An invoice is arguably the most common business document that companies issue after the sale but before the payment. It’s a document that works as evidence for the transaction, listing all details, such as company names, product or service description, dates, amounts, taxes, and payment details.

While invoices can be issued using a spreadsheet, the most convenient way is to use an online invoicing solution, many of which can be used at no cost.

Who needs to pay attention: All entrepreneurs and accountants
Learn more: Commercial invoice elements and What is an invoice number and why you need it

  1. Invoice payment terms – e.g. NET 15

Most invoices work as a request for payment, meaning that they include all the details on the payment method and payment terms. There are commonly understood keywords that signal to the buyer when the payment is expected to arrive. For example, NET 15 means that the payment should be made no later than 15 days after the invoice date.

Who needs to pay attention: The person responsible for making and receiving payments, and issuing invoices
Learn more: Invoice payment terms explained (with examples)

  1. Invoice vs receipt

While invoices are perhaps more common, sometimes you’re expected to issue a receipt, and thus it’s essential to know the difference.

Invoices are issued as a request for payment, meaning that they’re sent to the buyer after the sale but before the payment. Receipts, on the other hand, are issued as an acknowledgment for payment – after the money arrives.

Who needs to pay attention: The person responsible for making and receiving payments, and issuing invoices
Learn more: The difference between an invoice and a receipt

  1. Proforma invoice and estimates

Some businesses use pro forma invoices which are preliminary bills of sale issued and emailed to the client before the sale and before the payment.

A pro forma invoice is not really an invoice (yet) but a document aimed to encourage the client to make the payment. These invoices are typical for all recurring services when the sale is likely to happen but the client is not legally obliged to make the payment.

Who needs to pay attention: The person responsible for making and receiving payments, and issuing invoices
Learn more: Pro forma invoices – The complete guide for business owners

  1. Reclaiming VAT

Businesses who are registered for VAT can use the handy option to reclaim VAT from all VAT invoices they receive. Of course, only allowable expenses apply for reclaiming VAT, that is the ones incurred in relation to your business activities. VAT invoices need to include a full breakdown of all VAT details (VAT rate, net amount, gross amount, tax amount).

Who needs to pay attention: Business registered for VAT
Learn more: How to successfully reclaim VAT in four easy steps

  1. Self-employed vs limited company

One of the most important decisions that all business owners need to make at the very beginning is whether to start as a sole trader (self-employed) or as a limited company.

While self-employed have fewer responsibilities, limited companies may seem as more reliable business partners especially for companies looking to establish long-term relationships. Also, limited companies aren’t allowed to use the cash-based accounting method, regardless of their yearly turnover amount.

Who needs to pay attention: All entrepreneurs before they start their business
Learn more: Limited company vs. sole trader: which is best for you?

  1. Tax records

Tax records are all documents related to how taxes are calculated. Tax records include all documentation related to income tax, VAT, sale invoices, sale receipts, expense-related documentation, records on company assets, bank statements, as well as employee records.

There are regulations on the period that these records must be kept for so you need to make sure you follow the rules. Bear in mind that you don’t need to keep paper copies of invoices and receipts – electronic versions are okay in most cases.

Who needs to pay attention: All entrepreneurs and accountants
Learn more: Ultimate guide: How long to keep your UK tax records