Starting your own business can be exciting, but one of the first decisions you need to make is how your business will be structured.
For many people starting a small business, freelancing, contracting or a trade, operating as a sole trader can be a simple and cost-effective way to get started. However, it is important to understand the implications for your tax, personal liability, record keeping and future business growth.
At Roy A McDonald Accountants in Doncaster East, we help individuals and small business owners understand their options and establish a business structure suited to their circumstances and future plans.
What is a sole trader?
A sole trader is an individual who owns and operates a business in their own name or under a registered business name.
Unlike a company, the business and the individual are not separate legal entities. This means the owner is personally responsible for the business’s debts, losses and obligations.
A sole trader can still employ staff and operate a successful and growing business.
Sole trader businesses are common among tradespeople, consultants, freelancers, contractors and other small business operators.
What are the disadvantages of being a sole trader?
The biggest consideration is personal liability.
Because the business and you are legally the same entity, you are personally responsible for business debts and liabilities. This can potentially place personal assets at risk.
Business Victoria notes that a sole trader’s liability is unlimited and can include personal assets, including jointly owned assets.
This is an important consideration if your business involves:
- Significant financial commitments
- Employees or contractors
- Stock or equipment
- Commercial premises
- Borrowing or finance
- Higher levels of business risk
- Contracts with significant liabilities
- Plans to substantially expand the business
Appropriate insurance can help manage some business risks, but insurance does not replace the need to consider whether your business structure remains suitable.
What registrations do you need as a sole trader?
Before commencing business, you should identify which registrations, licences and permits apply to your particular business.
These may include:
Australian Business Number (ABN)
An ABN is commonly required when carrying on an enterprise. It is used when dealing with customers, suppliers and government agencies.
If you are carrying on an enterprise and do not quote an ABN where required, your customer may be required to withhold tax from payments to you.
Importantly, simply having an ABN does not automatically mean that someone is genuinely operating a business. Your activities need to meet the relevant requirements.
Business Name
If you trade under a name other than your own personal name, you will generally need to register the business name.
For example, if John Smith operates under “Smith Plumbing Services”, he may need to register the business name.
Registering a business name is different from registering a trade mark and does not automatically give you exclusive intellectual property rights over the name.
GST
GST registration needs to be considered carefully.
Generally, you must register for GST when your business’s GST turnover reaches or is expected to reach $75,000 or more.
Once registered, you will generally need to:
- Charge GST on applicable taxable sales
- Claim eligible GST credits
- Lodge business activity statements (BAS)
- Keep appropriate records
There can also be situations where GST registration applies even though your circumstances are not straightforward, so it is worthwhile obtaining advice before you commence trading.
Don’t forget about your own superannuation
One common mistake made by new sole traders is concentrating entirely on business income and forgetting about their own retirement savings.
Unlike an employee, a sole trader is generally responsible for making their own superannuation arrangements.
You should consider building superannuation contributions into your overall business and personal financial plan rather than treating super as something to think about later.
Personal superannuation contributions may also have tax implications and eligibility requirements, so professional advice can be worthwhile before making larger contributions.
What if you want to employ staff?
Being a sole trader does not prevent you from employing people.
However, once you employ staff, your responsibilities increase significantly.
You may need to consider:
- PAYG withholding
- Superannuation
- Payroll records
- Employment contracts
- Fair Work obligations
- Workers compensation insurance
- Payroll tax, where applicable
- Fringe benefits tax, where applicable
You should ensure your payroll and bookkeeping systems are established correctly from the beginning.
Keep your business and personal finances organised
One of the best habits you can develop as a new business owner is to keep your financial records organised from day one.
We recommend considering:
Separate business banking
Use a separate bank account for business transactions wherever practical. This makes it much easier to identify business income and expenses and monitor your cash flow.
Accurate bookkeeping
Keep your records up to date rather than waiting until tax time.
Digital accounting software
Software such as Xero can help you track income and expenses, reconcile bank transactions, prepare reports and provide greater visibility over your business finances.
Keep supporting documents
Maintain invoices, receipts, bank records and other documentation required to substantiate your business transactions.
Good record keeping can save significant time and reduce stress when your tax return and BAS are due.
Understand your cash flow – not just your profit
A business can be profitable on paper and still experience cash flow problems.
As a new sole trader, you should monitor:
- Money coming into the business
- Outstanding customer invoices
- Regular operating expenses
- GST obligations
- Income tax obligations
- Superannuation
- Loan repayments
- Upcoming large purchases
- Your personal drawings from the business
Preparing a basic cash flow forecast can help you identify periods where you may need additional funds before the problem arises
Remember that your tax bill is not the same as your business profit
Another common mistake for new sole traders is spending all the money received into the business without setting aside enough for tax.
Your business may generate strong cash receipts, but you need to allow for your future tax obligations.
Depending on your circumstances, you may need to plan for:
- Income tax
- GST
- PAYG instalments
- Superannuation
- Other business expenses and obligations
A simple tax and cash flow plan can make a significant difference to your ability to manage your business finances throughout the year.
Is a sole trader structure right for a growing business?
A sole trader structure can be a good starting point, but it is not necessarily a structure you will use forever.
As your business grows, your circumstances may change.
You may eventually:
- Employ more staff
- Increase your turnover
- Purchase significant assets
- Take on greater commercial risks
- Bring another person into the business
- Want to retain profits in the business
- Purchase property or other investments
- Plan for the future sale of the business
- Need to consider asset protection
- Want to separate business and personal affairs more clearly
At that point, it may be appropriate to review whether a company, partnership or trust structure could better suit your circumstances.
Importantly, you do not have to wait until there is a problem before reviewing your structure.
Business Victoria confirms that your business structure can be changed as your business grows or your circumstances change.
Don't choose a structure simply because it is "easy"
There is no single business structure that is right for everyone.
A sole trader structure may be suitable for one person but inappropriate for another.
Before deciding, consider:
- What type of business are you starting?
- How much income do you expect to generate?
- What level of commercial risk is involved?
- Will you employ staff?
- Will you have business partners?
- Do you need to purchase significant assets?
- Do you plan to grow the business?
- Will you want to retain profits within the business?
- What level of asset protection may be appropriate?
- What are the tax and administration costs of each structure?
Getting the structure right at the beginning can help avoid unnecessary costs and complications later.
Starting a sole trader business? Get the right advice first.
Starting a business is about more than registering an ABN and sending your first invoice.
You need to consider your business structure, taxation, bookkeeping, cash flow, registrations, insurance and future growth.
At Roy A McDonald Accountants, we have been helping local Doncaster East and Manningham businesses with accounting and taxation for decades.
We can help you with:
- Choosing an appropriate business structure
- Business and tax planning
- ABN and GST considerations
- Business registrations
- Xero setup and implementation
- Bookkeeping processes
- Cash flow planning
- Tax planning and tax minimisation strategies
- Business growth planning
- Structure reviews as your business develops
- Ongoing accounting and taxation support
Thinking about starting your own business?
Before you register your business, speak with an accountant about your proposed structure and plans.
Contact Roy A McDonald Accountants in Doncaster East to arrange an initial consultation and discuss how we can help you get your business started on the right footing.
This article provides general information only and should not be relied upon as specific financial, taxation or legal advice. Your circumstances should be considered individually before establishing or changing a business structure.
Source: Business Victoria
