Last Updated on September 18, 2024 by admin
What is a sole trader?
A sole trader is a self-employed person who owns and runs their business independently. A sole trader has no company set up and has absolute control over their business, its assets, and profits after tax.
As a sole trader, you are liable for paying your tax and personally responsible for any debts incurred by the business.
Advantages of a sole trader
Fewer overheads:
Having full control over your business operations, fewer administrative requirements are needed increasing the flexibility in decision-making. This can also be advantageous in terms of expenses since you will have fewer overhead costs.
No barriers to entry:
No entry barrier exists for sole traders making it an easy and accessible option for entrepreneurs. Setting up a sole trader is quick and simple since there is no need to register a company with Companies House. However, you still need to inform HMRC that you are self-employed and operate your business as a sole trader.
Use your personal bank account:
As a sole trader, you are not legally required to open a business bank account making it okay to use your personal bank account for business transactions and manage your expenses and finances.
Save on annual company fee:
Sole traders do not have to pay annual company filing fees or comply with statutory filing requirements that limited companies have. In addition, they don’t pay corporation tax on their profit.
Perk savings:
As a sole trader, you can keep all profits after tax and get a tax allowance if you earn £12,000.
Additionally, if you need to purchase office equipment to operate your business, you may be able to claim capital allowances.
People may be more attracted to doing business with sole traders than large businesses:
Due to their personalized service and direct communication, people may be more attracted to sole traders than large entities. Sole traders may build a stronger relationship with customers due to familiarity and direct communication.
Disadvantage of a sole trader
Pay more tax than you need to if you expand:
When your business starts expanding, you may face an increased tax obligation. As a business grows, its revenue and profits increase making your income exceed the threshold for higher taxes. Expanding may also lead to additional expenses and costs that could impact the overall tax burden.
It can get difficult to separate personal and business transactions:
Using a personal account for your business brings about confusion in your transactions making it hard to account for your business expenses making you look unprofessional.
Hard to attract new customers:
Many clients may prefer to deal with larger companies due to workmanship. Some clients may believe that large entities will get work done faster since they have a team or employees.
Limited reach and visibility in the market can be another factor that may contribute to the difficulty in attracting new customers as a sole trader. Lack of a strong online presence on social media platforms and networking might limit you in attracting new customers.
Employing staff can be hard:
As a sole trader, employing staff can be challenging especially when dealing with Pay As You Earn (PAYE) tax regulations. You will personally be responsible for complying with employment laws and handling payroll taxes.
Before employing staff, you will need to register as an employer with the HMRC and then register for PAYE to start paying your staff. Once you become an employer, you must take out an employer’s liability insurance policy which protects you if an employee becomes ill or injured because of their work. Every day that you employ someone without this policy, you can be fined an extra £2,500.
This may be challenging since this requires a significant amount of effort, time, and resources that a sole trader may not have.
Hard to get government incentives:
Government incentives may require formal structures making it difficult for sole traders to qualify for certain incentives or programs that are typically available for larger entities. As sole traders typically operate with limited resources, they may face difficulties in navigating the complex application process.
Hard to get a loan from banks:
It can be difficult for sole traders to get a bank loan to expand their business. Banks may be unwilling to lend large sum amount of money to sole traders because they may not have collateral or assets in exchange for the investment.
Banks may also be hesitant to offer sole traders a loan due to the perceived greater risk associated with smaller businesses.
When is the right time to change to a limited company?
The right time to change to a limited company varies from one business to another. Some businesses may decide to change from sole traders to limited companies when they start signing big contracts or generate more income. When your earnings start to pick up, it becomes more economical to move to a limited company protecting you from tax obligations. However, you will have certain costs as a limited company that you don’t have as a sole trader.
Additionally, the right time to change to a limited company may be when you need increased financial backing. It is easier to secure business loans and investments as a limited company since its structure allows the company’s finances to remain separate from personal funds.
If you want to protect your assets, transitioning to a limited company may be prudent. In contrast to sole trader, debts accumulated with a limited company will not affect your assets. In the case of buying or owning properties, you may benefit from stamp duty charges and greater taxation since it won’t be in your name.
When trying to win a potential client or secure new contracts, you will have to shift to a limited company which will increase your professional image.
So when is the right time to change from a sole trader to a limited company? Well, a quick answer to that is that time may differ for each business. Transitioning from a sole trader to a limited company can support many aspects of your business, however, it is important to weigh out your options properly.
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