How to Save for Tax

Video Transcription

Today we will talk about how to set your business up using the four accounts method.

One of the things that may inhibit you from growth is not knowing how much you can spend on growth and how much you can afford to operate your business.

One of the big things that gets in the way of understanding how much of your cash you can use to grow is understanding how much of that cash is already committed to tax bills, for example.

So, I will show you a methodology that we recommend that will help you give a clearer picture of what is left in your business to spend on growth.

Whiteboard Account Example

So we’re going to just turn to the whiteboard for a minute, and we’re going to assume that we’re looking at our example company of Grow Limited, and in Grow Limited, we have set up a business current account.

Paid in Account

So I’ll just put biz current on this top box here and into the business current account is where we get paid from our customers. So we get paid into our business current account.

Business Savings Account

Now, in this bottom box, we recommend you set up a savings account for your second business account.

And from the business current account, if you’re going to be paid by your customers into the business current account, we recommend using your business savings account to put in money related to VAT and corporation tax.

So, using Grow Limited, which is the example of a VAT-registered business, which is most of our clients, you’re billing customers inclusive of VAT at 20%, and corporation tax is about 19%. So, we recommend that about a third of what you get paid be transferred to your business savings account.

So that third is about 20% for VAT and about 13% for corporation tax because remember corporation tax is on profit not on your revenue. So, as a rough rule of thumb, about a third move into the business savings account. That means you’ve got two-thirds left in your business current account and a third in your business savings account.

So, when it comes time to pay your VAT bills and your corporation tax bills, you can pay those to our good friends at HMRC, as and when they fall due.

Personal Current Account

This gives you the benefit of knowing exactly what you’ve got in your current account that has nothing to do with business taxes in the second two boxes here.

This is where we’re looking at you as a business owner and your personal bank account. So we’re going to put personal current account here and we’d also recommend you have a personal savings account. So, it is very similar set up to the business hence the four boxes

And you’re going to be paying yourself each month, and if you’re a Next Level Business client, we work with you to understand what your drawings are likely to be and whether that’s going to be a make-up of salary dividends or something else.

But, whatever you’re paying yourself, you’re transferring that from the business current account, out of your two-thirds that’s left, out of tax. You’re transferring that into your current account. So, that is what you’ve paid yourself in the month. Now, from your personal current account.

Personal Savings Account

You should also have set up a personal savings account. And as soon as you pay yourself into your personal current account, we’d recommend that you also, in the same way, you’re putting money into your business savings account, you also pull some money into your personal savings account.

Now, obviously, that amount of money that needs to go into your personal savings account will vary depending on how much you pay yourself and what rate taxpayer you are.

But that could be anything from 5% to 30% of your earnings. So let’s take something bang smack in the middle around 20%. So whatever you’ve paid yourself into your current account, move 20 percent into your savings account. Leaving you 80 percent to spend on whatever you want, knowing that everything that you’ve got in your current account is, you know, available for you to spend. You might also want to put money into other things.

An Example of Accounts

That’s fine, but at least you know what you’ve got to play with that’s not going to be in tax, so let’s run through a quick example here:

If your business is invoicing a hundred pounds on an invoice, you’re going to get paid 120 into your current account.

So 120 pounds is going to come into your current account. Of the 120 pounds, we owe approximately 20 pounds of that in VAT. And we’re saying about, you know, a third in total. So another 13%, roughly speaking, for sort of corporation sacks. So a third of 120 pounds must go into your business savings account.

So transfer that money across to there. Once you’ve done that, the balance that’s left, you can transfer and pay yourself. Let’s say you pay yourself.

For example, £40, into your current account. So, £40 has come in, and you’ve been paid into your personal current account 20% of 40 pounds is 8 pounds, so you put 8 pounds in your personal savings account, leaving you with 32 pounds in your personal current account.

So, a quick worked example for you.

The 4 Account Process

But, the process is I think quite clear there. Whatever you get paid, move about a third into your savings account, ready to pay your taxes here.

Pay yourself an amount, of that a percentage, and we can help you work out that right percentage for you, into your personal savings account. That way, whenever you need to pay your tax bill, money is available and separated from your business current account and from your personal account.

The benefit of all of that is you know exactly what’s left in your business’s current account for you to spend on growing your business, supporting it and business expenses without worrying about what your tax bill will be and how much money you’ve got available for that.

Top Tip

So, our top growth tip is to know what you’ve got to play with, put money aside for your tax savings, both business and personal, and that will give you a war chest left to invest into your business. See you next time.