Sole Trader Profit

Patrick05021989

Good evening, hope you're all well.

Cut a long story short - I am in a process of starting out as a self employed online retailer. It might be relevant to the post that I am already in full time employment, earning a salary of £32880, therefore paying TAX & NI. This will remain unchanged as I intend to "trade" in my spare time.

I am being realistic and not expecting to generate a profit of more than £3-4k in a full year of trading.

I've researched different methods of accounting and settled on the "cash basis" method as it seems to be the most simple one - the only requirements are: total expenses & income.

However, when I say simple I don't mean straight forward ( to me that is )...

My intention is to initially invest/purchase stock for approx £1500 with intention to sell it within 3 months for £3k.

At this stage I will have generated a turnover of £3000 with a gross profit £900, however, I am out of stock...

If I decide to reinvest the full £3000 in stock, will I still be liable to pay tax on the £900, or will the profit only be calculated at the point of self assessment ( total annual expenses - total annual income = gross profit/loss ).

I think I am getting confused with traditional ( accrual ) method and the cash basis method, but just can't get my head around it.

I would love to hear any advice.

Thank you.
Patrick

anselld

Cash basis...
You buy for £1500, you sell for £3000 ... £1500 profit.
You buy another £3000 ... becomes £1500 loss. (Until you sell again).

Not sure where your £900 comes from.

Dazed_and_confused

Reinvest £2995 in new stock and £5 on a calculator!

Patrick05021989

Anselld - Thank you.

Dazed & Confused - well you certainly have left me confused... for the life of me I can't see the purpose of your post other than thriving from being sarcastic?

I didn't want to bore you all with additional costs involved in the sale, such as:

* P&P
* Ebay fees
* Paypal fees
* Monthly ebay store subscription ( Requirement for Buy 2 get 1 free offers )
* Quickbooks subscription

Didn't think the "add on" costs were relevant to my question, although I could have worded it differently.

£900 as mentioned above is my gross profit from the £3000 sales, after all expenses, not just the stock.


Thanks

TheCyclingProgrammer

The reason for the confusion is that you are confusing gross profit and operating profit. Your gross profit is your sales less cost of goods sold, so if you sell £1500 of stock for £3000 your gross profit is £1500.

00ec25

Patrick05021989 wrote: »

will the profit only be calculated at the point of self assessment ( total annual expenses - total annual income = gross profit/loss ).

your net profit is calculated at the end of the tax year if you are a sole trader and therefore your "year" is the same as the tax year

it appears that your business will effectively be a "cash" one anyway in that you will be paid immediately for what you sell since your sales will (I assume) be through a website where the customer must pay at the point of checkout given you say you will be an online retailer. Therefore, your sales are on the cash basis anyway since no cash = no sale, unless you intend to give stuff away to those who don't pay for it? (sarcasm)

your expenditure will be on the purchase of stock and other expenses. Obviously we do not know where you will buy that stock from, or on what terms it will be supplied to you. If, like you do to your customers, you have to buy from a wholesaler who makes you pay before your leave the warehouse, then your stock expenses are immediately included in your profit calculation since they are on the cash basis, ie you've paid for them. If on the other hand you physically get your stock and are then given an invoice by your supplier and you string the supplier on and don't pay him until, say, 60 days later, you cannot include that cost in your profit calculation until you pay it 60 days later.

the same principle applies to your non stock expenses ... when do you actually pay for them? that is what counts for the cash basis.

Consider 3 examples...
Example A) Cash accounting basis:

• Stock: go down warehouse on 25th March, buy £60 stock, you pay in cash as you leave the door of the warehouse. Your bank account decreases by £60 because you took £60 cash out to pay the warehouse.
• Sales: put that stock on sale on your website priced at £100. Customer buys it on 1st April and pays at point of online checkout. Your bank account thus increases by £100 on say 4th April when the money reaches you via your online shop system (3 working days later)
• Profit: As at tax year end on 5th April your sales are £100, your expenses are £60, you have made £40 of taxable profit. You pay tax of £8 being 20% of £40 (your employment income 32,880 + your self employed £40 profit is still well within the basic rate tax bracket hence your profit is taxed at 20%).

Example Cash accounting basis:

• Stock: go down warehouse on 25th March, buy £60 stock, warehouse gives you an invoice dated 25th March but they sold the goods to you on "credit" terms. Their terms are all invoices to be paid within 30 days so you pay via online banking on the 24th April so the cash leaves your bank account that day.
• Sales: put that stock on sale on your website priced at £100. Customer buys it on 1st April and pays at point of online checkout. Your bank account thus increases by £100 on say 4th April when the money reaches you via your online shop system (3 working days later)
• Profit: As at tax year end on 5th April your sales are £100, your expenses are £ZERO, you have made £100 of taxable profit. You cannot bring the £60 stock cost into your profit calculation as at the tax year end date of 5th April because you did not pay for the goods you purchased until 24th April, which means that cost falls into the next tax year.

You pay tax of £20 being 20% of £100 profit made in that tax year. Obviously this is very bad for you because your real trading profit remains 100 - 60 = 40. But because you paid your supplier after year end, your taxable profits are artificially high as you have no expenses at all under the cash basis.

Example C) Traditional ("accruals") accounting basis:

• Stock: go down warehouse on 25th March, buy £60 stock, warehouse gives you an invoice dated 25th March but they sold the goods to you on "credit" terms. Their terms are all invoices to be paid within 30 days so you pay via online banking on the 24th April so the cash leaves your bank account that day.
• Sales: sell £100 of stuff to a customer on 1st April. Customer pays at point of online checkout. Your bank account thus increases by £100 on say 4th April when the money reaches you via your online shop system (3 working days later)
• Profit: You ignore when cash leaves or comes into your bank account. You account for sale £100 on the day the customer bought them (1st April) and your expenses on the day the supplier invoiced you for them 25th March. So as at 5th April your accrual basis is sales £100 expenses £60, taxable profit 40

In the real world there is a very clear advantage to using the cash basis if you have lots of transactions to keep track of because you only need to record them when the cash goes in or out of the bank. In contrast for traditional accounting you must record each transaction on the correct date so your bookkeeping needs to be of much higher standard (ie it will cost more in accounting fees!). There are of course other advantages but i can't be bothered to think of or list them at this time of night

Patrick05021989

Thank you all for the great input!

00ec25 - Your reply is just amazing!

I would say example 3 describes my intentions perfectly.

Stock: go down warehouse on 25th March, buy £60 stock, you pay in cash as you leave the door of the warehouse. Your bank account decreases by £60 because you took £60 cash out to pay the warehouse.
Sales: put that stock on sale on your website priced at £100. Customer buys it on 1st April and pays at point of online checkout. Your bank account thus increases by £100 on say 4th April when the money reaches you via your online shop system (3 working days later)
Profit: As at tax year end on 5th April your sales are £100, your expenses are £60, you have made £40 of taxable profit. You pay tax of £8 being 20% of £40 (your employment income 32,880 + your self employed £40 profit is still well within the basic rate tax bracket hence your profit is taxed at 20%)

Could please clarify, what happens if following the sale of the 2nd item I then purchase a 3rd one for let's say £150, but fail to sell it within the tax year.

A) Am i still liable to pay tax on the £40 from the initial sale?
Effectively I have made a loss of £50, therefore no Tax to pay.

From what I have read so far, my assumption is that the option B is applicable, but please correct me if I am wrong?

My theory:

With cash basis accounting, there is no requirement to conduct closing/opening stock levels, therefore my account would close with a loss of £150, and reopen with the same figure for the following tax year.

As soon as my item is sold for lets say £200 my profit then goes up to £100 and assuming that no further purchases/sales are made during that year ( omitting paypal fees, P&P etc. ) my tax bill would be £20.

Is this correct?

Also, if anyone would be so kind could you please advise me what paypal charges are classed as?
If it is classed as bank charges ( I don't think it should be since it is not interest on borrowings etc. ) - does this mean that I can only offset £500 worth of charges?


Many Thanks
Patrick

TheCyclingProgrammer

I would classify Paypal fees as bank or finance charges.

Patrick05021989

Thank you,

I was under the impression that this would be a cost of sale ( the same as ebay fees ).

Am I right in assuming that anything over the allowable £500 would be taxed at 20%?


Thanks

TheCyclingProgrammer

You will pay tax on your net profits. This is your gross profits less overheads and any other tax deductible expenses. The rate of tax depends on how much profit you've made and any other income you have earned.

00ec25

Patrick05021989 wrote: »

Thank you,

I was under the impression that this would be a cost of sale ( the same as ebay fees ).

Am I right in assuming that anything over the allowable £500 would be taxed at 20%?


Thanks

neither paypal charges nor e bay fees are costs of sales if you want to be technically accurate , they are simply all bank charges and are classed as admin expenses

you do not seem to have understood the answer you have been given several times so far

sales - costs = taxable net profit

the figure for gross profit is not the figure you pay tax on. Gross profit is a figure that is used for monitoring the financial health of your business idea. There is no point buying something to sell if you cannot sell it for a lot more than it cost to buy as your gross profit margin has to cover both all the other costs you incur + leave you with a post tax net profit you keep for yourself.

PS the £500 "bank charges" limit relates to the interest charged on borrowing, and stems from technical knowledge you lack. Legislation prevents interest charged on a loan from being claimed at all under the cash basis, however, an express exception is made which allows up to £500 of interest to be charged and reported in box 25
https://www.gov.uk/hmrc-internal-manuals/business-income-manual/bim70040
Note it refers to interest, not "bank charges"
e bays fees, paypal fees and any transactional charges made by your bank are all classified as bank charges but are not subject to the £500 limit as they are not interest charges.
Anyway if your annual turnover (ie sales) is less than £83,000 you do not have to split out your expenses on the tax return, you just put a lump sum in box 20 on SA 103S (short)
https://www.gov.uk/self-assessment-forms-and-helpsheets

however, it if helps you understand then do look at the rules for "bigger" businesses where the interest charges are reported separately from all other bank charges boxes 25 & 26 on SA 103F (full)