Chapter Five
INCOME FROM SELF-EMPLOYMENT
Sally runs her own business. A glamorous hairdresser in her thirties, she bubbles with energy and ideas. With a mind quick to take decisions and the determination to see them through, Sally typifies the self-employed businesswoman. If you had to sum up Sally in one word, it would be organised.
Traditionally, very few women take the plunge into self-employment. Part of the reason is that girls opt for the sort of training that leads to employment. The only apprenticeship commonly open to girls if hairdressing. As a result, many women go on to run their own salons with great success.
Another drawback is that to start many businesses you need capital or to be able to borrow it. Yet most women find the biggest deterrent is the complete commitment the business demands. As the Americans say, starting a new business is like producing a baby. For success, the whole family must want and prepare for it.
Sally knew before she started that she would need to work very long hours with no guaranteed wage waiting at the end of the week. She accepted that she would not know whether the business was successful for a long time - not even if clients came flocking and she was run off her feet.
Besides, she would have to record every penny in and out in painstaking detail, then prepare accounts for her salon or pay someone else to do it. She would have to contend with VAT on what she bought and sold and calculate PAYE forher employees. At least, in a cash-only business, Sally does not have the additional worry of customers who don't pay.
On top of all this, Sally knew what could happen if her salon flopped in favour of the up-market branch of a national chain of hairdressers down the road, or the cut-price barely trained girls who call on people at home. Debts would mount faster than she could earn the income to pay them. If she found herself overwhelmed by more debts than she could pay, Sally might have to sell everything (including her home) to pay them off.
No one would volunteer for all that worry and hassle if there were not terrific advantages to compensate - and there are.
WHO IS SELF-EMPLOYED?
Remember that an employee has a contract of service? A self-employed person has contracts for services, one with each customer or contractor. These contracts are simply agreements - they need not even be written down - between the self-employed person, like Sally, and the person who wants their services. You have made dozens of such contracts.
Every time you visit your hairdresser and pay them to tint your hair, you enter such an agreement  - just by making an appointment. You would not dream of telling them how to wash your hiar, let alone, cut, style or colour it. They provide the salon, the basin, the hot water, the shampoo, the conditioner, the drier, the magazines, the cup of coffee, everything down to the appointment card.
If the owner, like Sally, or anyone she employs, makes a botch of the job or stains your clothes, it is the owner who must compensate you out of the business money. You never employ anyone in the salon, although they are doing something for which you pay them. Sally herself enters a contact for services when she calls up the self-employed plumber to unblock her sink.
Sally is genuinely self-employed. In addition, you will meet a growing army of 'sham' self-employed, with no real business behind them, the vast majority male. Why?
The distinction between employees and the self-employed, between one sort of contract and another, grows more blurred all the time. Hospital doctors are employees of the NHS, but no one stands over them in the ward and tells them how to hold their stethoscopes.
In fact, any male who could possibly claim to be self-employed, fights tooth and nail to be accepted as such by the Inland Revenue because of the tremendous advantages. I have even seen petrol-pump attendants try it on. Their boss, the garage owner, will support them too. If you take on a self-employed person to do work for you, you don't have to deduct PAYE tax or National Insurance contributions. You avoid employer's National Insurance. You don't even have to bother with safe conditions at work.
Next time you pass a building site, look around at the carpenters, bricklayers, painters and plasterers hard at it. Virtually every man-jack of them will be officially self-employed. Yet they may work for one employer for twenty years. Probably the only employee in the place - the only one to pay PAYE - will be the girl in the office. Here you see the 'sham' self-employment. They are really employees but enjoy all the advantages of being self-employed.
WHY BE SELF-EMPLOYED?
If you talk to anyone who is self-employed they are certain to complain that they are hard done by and penalised by the Inland Revenue and the DSS. Reach for the salt and take a good pinch. The opposite is true. Otherwise, people would not rush to be self-employed - people like contract milkers, who just drive from farm to farm fitting rubber suction pads on cows' udders, farm secretaries, private nurses, insurance agents and pool coupon collectors.
So what are these marvellous benefits that the self-employed enjoy?
1. You pay your taxes much later. Employees have already paid their taxes before they even open their wage packets and count the notes. When a self-employed person starts up a business it is usually nine months before the Inland Revenue even contact them.  The Revenue do this deliberately. They leave you in peace to get established. For ever after, you pay your tax very late.
Take the year from 6 April 2000 (tax years always start on 6 April) to 5 April 2001. Monthly paid employees pay tax from their wages at the end of April 2000, May 2000, June 2000, and so on, up to March 2001. The weekly paid pay even sooner. But self-employed people pay half their year's tax on 31 January 2002 and the rest on 31 July 2002.
Don't worry if you don't understand why the dates should be so different. Take it from me, they are. Any tax office or accountant can confirm this.
2. Employees spend a lot of their earnings just travelling to work. But a self-employed person effectively runs their car (and maybe their spouse's car ) out of the business. In other words, the buying and running of the car are treated as a business expense. This expense reduces the amount of tax that self-employed people pay on their profits. Very nice! And the rules are even more generous. If you are self-employed , much of your private motoring is treated as a business expense too - taking the family to the seaside, for instance, as long as you stop off to deliver some samples to a client on the way.
3. Many of the self-employed live out of the till. All the receipts of the business are under their control, and they are also responsible for the record-keeping. So it is not difficult in a cash business, like a shop, for owners to take money directly from the till to spend on themselves and their family. Unless this money has been recorded already, it is not included in the sales of the business. So the owner never pays tax on it.
This is, of course, dishonest and illegal, because you are cheating the Inland Revenue. But it does explain why the average self-employed person declares profits which are below the old-age pension level! Otherwise you might wonder why anyone would work so hard and such long hours for nothing.
4. Depending on the type of business, owners can benefit from what they sell. A pharmacist will not go to a rival pharmacist to pay cash for her make-up, her soap, her perfumes, for cough-syrup for the family, or house-cleaning products, for Christmas presents - or to swap for the fruit and vegetables sold by the nice woman next door. She will take stock from her own shop, perhaps damaged stock, and maybe she will record the fact. Again, she may order articles from her wholesaler, at wholesale prices, with no intention of selling them in her shop. She will keep them for herself, although the business paid for them.
5. An employee has to struggle very hard to persuade the Inland Revenue that he or she ever lays out a penny to do his or her job better - not so the self-employed.
When I was an employee, I bought a pocket calculator in the days when they were rare and expensive. I kept it in my desk drawer and used it solely for work. The Inland Revenue refused to allow me to deduct the cost of either the machine or the batteries to run it from my salary. They argued, quite legally, that if your employer decides you need something, the employer will provide it.
Sally, as a self-employed person, never has this problem, because she alone decides what she needs. I remember one jeweller who decided he needed a Rolls-Royce to deliver repaired jewellery to his clients' mansions. Any lesser vehicle would have devalued his stock!
6. Many self-employed people 'live on the job'. Perhaps they run a farm, a hotel, a guest house, a convalescent home or a pub; or they simply occupy an ordinary house with part converted into surgery or an office. They can all claim part, and sometimes most, of the cost of their domestic electricity, heating and telephone bills as a business expense. Others claim these expenses because they do some work, perhaps writing up the books, at home.
I have known pet food claimed as pest prevention or security expenses, and children's ponies claimed as farm animals. I even heard of one farmer who claimed the cost of his swimming-pool. He pointed out that the farm was isolated, and if the hayricks caught fire, the fire brigade would need the water to put the fire out. The Inland Revenue took him to court, but he won his case.
7. As a self-employed person, Sally can employ whom she likes. The cost of their wages is a business expense. Of course, these people should be working in the salon, but it has been known for them to do the owner's housework, mind her children or do repair jobs around her home as well.
There is nothing to stop a self-employed person paying a salary to other members of the family. How many wives reading this receive a salary according to their husband's accounts that they never even knew about, let alone received? This may apply to children too, or to Granny.
One of my pilot clients flew a crop-sprayer. He paid both his pre-teen sons to stand out in the field and be sprayed over. Although highly dangerous, it was the best way to identify the right field from the air. If he sprayed weed-killer on the lettuces growing in the next field by mistake, he would have massive compensation to pay. Alternatively, Farmer Giles might grin to see his wheat showered by Farmer Brown's expensive fertilizer, but Farmer Brown would not be so delighted.
Shunting money around the family is a common way of saving tax. Bear in mind that anyone can earn broadly £4,000 (2005 figure) a year before they need worry about tax and National Insurance.
These are just a few examples. Some are acceptable. Others are not. All happen regularly. I am not suggesting that you become dishonest, but simply pointing out that if employees knew what the self-employed get away with, there would be a revolution.
The Inland Revenue knows. They combat it every day. Most of their disputes with the self-employed fall in one of these areas. This is why a second amount of  National Insurance (called Class 4) was introduced. Only the self-employed pay it. The aim was to make things fairer compared to what employees pay. In fact, the extra is still tiny. Lump together employee's and employer's contributions, and the government claws in far more for each employee than it does from the self-employed, including the Class 4 payment. Besides, the self-employed pay this National Insurance late, at the same time as income tax.
If you find all these self-employed tricks shocking, remember that life is rarely black and white. Even the most careful record-keeper will mix up business and private expenses. One shopkeeper I knew clocked up 10,000 miles in his car in the year. He said he drove 9,000 miles on business and only 1,000 on taking the kids to school, etc. So nine-tenths of the buying and running costs of his car were claimed as a business expense. Is this reasonable? You cannot judge until you know his circumstances. That said, accountants are paid to spend much of their time negotiating favourable compromises with the Revenue on behalf of their clients.
Take Sally. How many miles a year would you expect a hairdresser to drive on business? Regular trips to the bank? To her accountant? Perhaps to her solicitor about the lease, or to a plumber to dispute his outrageous bill for stopping a leak in the salon in the small hours? Yet Sally will remember the elderly customer who fainted under the drier and whom she had to drive to hospital; the brave house-bound woman with multiple sclerosis whom she collects from her home and returns (this does happen); the staff she had to ferry around during the transport strike. There is no hard-and-fast rule, and Sally's mileage will vary from year to year.
RECORD-KEEPING
We said that Sally must keep records, just like every self-employed person: records of how much she spends and what on, how much she receives and what for. There are several reasons why record-keeping is essential if you are self-employed;
1. To account for V.A.T. on what you buy and sell.*
2. To account for PAYE for any employees you have.
3. To hand to an accountant to prepare your accounts. These accounts fulfil two purposes. First, you must supply a copy to the Inland Revenue to calculate your own income tax. And second, you accounts tell how you are progressing - have you made a profit and, if so, how much? Are you running your business efficiently? Where could you improve?
GETTING STARTED
Now you have discovered the advantages of self-employment, how do you get started?
If you are an employee and fancy the benefits of 'sham' self-employment, ask around. Is anyone else who does your job self-employed? Some call themselves freelance, on contract, contractors, commission agents or consultants. If they are, ask how they arranged it. Maybe if you ask the boss, he will agree to treat you in the same way. Remember the advantages to the employer.
In draughtsmen's offices, in accountancy firms, in hairdressing salons, in computer installations, you can watch two people working side by side at the same job. Yet one is self-employed and the other is not.
If you are unemployed and want to start up a genuine new venture, the government may give you money to set up your business. Ask about it at the DWP office and/or look on their website well before you start. www.dwp.gov.uk/  Look for Business Start-up run by Job Centre Plus on this site. Remember there are conditions to be satisfied. You must adjust your set-up to meet them all if you want to claim the money. No one will bend the rules to suit you.
Even if you are not officially unemployed, you may persuade the government or local council to help finance your new venture. There are all sorts of grants and subsidies and the offer of low-rent or even rent-free premises available. This is especially the case if you plan to operate in a run-down area, or if your venture will provide employment for others. Hunt out the areas officially selected for special help. Sometimes moving a mile from where you planned to set up can make all the difference.
I knew one client who obtained tens of thousands -  a gift, not a loan - to rescue a stately home in the heart of Wales that was falling apart and turn it into a hotel. Of course, he put up money of his own as well, and he could present a well-researched case and had a successful track record too. The money is available. It is up to you to track it down and prove your case.
Anyone who plans a real new venture, not sham 'self-employment', will have umpteen things to find out about, consider and decide. Sally had to find the right salon in the right place and arrange a lease. She had to arrange a bank loan, decide what redecorations to make, chose the stock to buy, order headed stationery for the new business, take on staff, etc.
Before she committed herself to a penny, Sally did her sums. She worked out what she would need and how much it would cost; how much money she could scrape together from savings and borrowings; how much she would have to earn to pay back her loans; how much she would have to charge; how many customers she would need to earn that amount and how long it would take her to pay off her debts.
Visiting the bank manager is excellent discipline for this. We look at these sums in more detail in Chapter 11 when we consider how to borrow successfully. Even if you can finance the whole show from your piggy bank without borrowing a penny, you must do the same calculations - to protect yourself.
ACCOUNTS, ACCOUNTANTS AND PITFALLS TO AVOID
If you are hoping to buy an existing business, you should ask the present owners to let you see the last three years' accounts, in confidence of course. Perhaps the accounts will not mean very much to you. They should make more sense when you have read this and the next chapter. You definitely need to show them to your accountant for advice before you decide to buy.
Of course, like Sally, you will fizz with new ideas of your own. But these accounts at least show what receipts and outgoings are possible.
No matter how small your business, I recommend at least one visit to an accountant. Choose one who is chartered (ACA) or certified (ACCA) because any unqualified person can still legally call themselves an accountant. Even if you intend to prepare your own accounts in future, an accountant can tell you:
-  what records to keep;
- what bank accounts to open;
- many pitfalls to avoid in starting up.
This should save you far more than the cost of the hour's consultation. (Besides, that cost counts as a business expense.) Have a list of all your questions ready to get the most out of your consultation.
Here are just a few of the expensive pitfalls that entrap people who set up their own businesses every week of the year.
You might spend thousands on buying a limited company off the shelf, because some know-all told you that you needed it. 'Off the shelf' means it is brand new and has never been used. (Do not be deceived by advertisements offering an off-the-shelf company for £50. This is merely the first of many large bills you will have to pay.)
You could spend thousands buying an offshore company because some ignoramus told you wrongly you would save tax that way.
Maybe you will start off as a husband-and-wife partnership when it would have saved you money for one (on paper) to employ the other. Or perhaps you will not start off as a partnership when you should have done.
Then again, you might buy the shares of an existing limited company to obtain its business. I will frighten you later on with examples of this dangerous pig in a poke (see Chapter 6).
The accountant can advise you on whether you would do better to work flat-out to open your doors for business on 1 April, in the old tax year, or hold fire and open after 6 April, in the new tax year.
Maybe your business has developed from  a hobby that just snowballed, and for years you did it simply for fun. Perhaps you collected antiques and now you think you know enough to start trading a few. An accountant can tell you when you officially started to trade.
Your accountant can advise you what date to choose to prepare your accounts. There is no set rule (unlike some countries). It need not be a year since starting. No card shop wants the extra burden of accounts, or stock-taking in the Christmas rush or the week before Valentine's Day. No farmer wants to devote himself to his books when clouds may threaten his harvest or all his sheep are producing lambs.
Some of these points may appear petty. They are not. Each can make a difference of thousands of pounds to the tax you pay and when. They can threaten or boost the whole future of your venture.
The accountant can also tell you (and this is vital) how much of what you take in you must set aside, on deposit in the bank, to cover future income tax, VAT and the like. Many newcomers gaily reinvest every penny that comes in, only to go bust when the first big unexpected tax bill arrives.
Perhaps all this seems too grand for the modest venture you have set your heart on. If you cannot think on this scale yet, go to a stationer's and buy a Simplex book to keep details in. You absolutely must keep all receipts. Make a note of all you spend even when you don't get a receipt. For example, when you pay the window cleaner, a little note scribbled 'Window cleaner £15, 9 June', pushed into the till will do.
If you give credit or do your work before you send out invoices (bills) to clients, monitor closely the number of customers who don't pay. Don't just grind your teeth and try to forget about them.
Non-payers and late-payers probably cause more new businesses to capsize than anything else**.  You waste time and money doing the work and then again as you try to get paid. Worse, you may be forced to borrow when they don't cough up as promised.
If you are still in business after a year (two out of three people will not be - running your own business is that demanding), I again recommend you to go to a qualified accountant and pay for them to prepare the accounts for your first year. They can set you up right.
You cannot imagine how important that first set of accounts is. Even if it only records your trading for the first twelve months, it normally fixes how much tax you pay for longer than that. Any tax office will confirm this. In future years you can always update the accountant's figures and economize that way if need be.
*I will not go into more detail about V.A.T. here. If you need to know, the Customs and Excise Department produce excellent booklets. And they can tell you in ten seconds over the phone whether your business needs to register. They will call in to explain all the details if you ask them, or give you a clear 'yes' or 'no' on any query. Compared to income tax and the welfare state, VAT is child's play. Of course, Customs and Excise Department is merging shortly with the Inland Revenue to form H.M. Revenue and Customs. They will need a monster website.
**Thousands also go under because of computer-users who did not take regular back-ups and keep them safe away from the office. A computer problem or its theft and you are destitute.
ACCOUNTS - IN MORE DETAIL
Just what are these accounts, this sheet or two of paper, on which I recommend that you spend several thousand pounds?
Every business will need a profit and loss account. This is sometimes called an 'income statement'. Every business but the tiniest will also need a balance sheet; another name is a 'statement of assets and liabilities'.
The profit and loss account records what came in and what went out in the year. The difference between the two is the profit (or loss). Perhaps you think your bank statements already show all this. Well, they are important documents for a starting point but can never give the full picture.
You paid for many items in advance. Perhaps you paid three months phone rental or twelve month's car insurance yesterday. Then there are other bills you know will come but you have not yet received, like the car service or an electricity bill. You paid in cheques which have not yet cleared. You bought stock but have yet to sell it. Your bank statements ignore all these factors, whereas your accounts include them.
The main question is, did you make a profit? If so, how much? Did you simply break even, in which case you worked hard for nothing? Or did you suffer a loss, in which case you are worse off now than you were before you started?
Table 1 shows the profit and loss account for Sally's Salon for her first year. Accountants may set out their figures in slightly different ways, but this layout is typical. The figure of £4,499 is underlined to show that the whole column of figures is being added together. You will see that the total comes to £33,622. This is put in the next column and inside brackets to show that it is being deducted from the takings. The result gives us the profit of £19,834.
Not difficult is it? The figures don't matter much - except to Sally - so long as you grasp the general idea. If all Sally's expenses had come to £63,456 instead of  £33,622 then she would have made a loss of  (£10,000). Losses are put in brackets too.
'Miscellaneous' covers all the odd small expenses, like the window cleaner and Christmas decorations, that are not worth recording separately. Another name for them is 'sundries'.
I have encountered lots of businessmen who paid for accounts and did not even understand this much. For a start, they confused takings (sales, receipts - call them what you like) with profits. They thought that because they rang up £53,456 on the till in the year, this was the profit they made.
You may be working hard, and your shop may be full of paying customers. You may even reluctantly turn people away. But this does not mean that you are making a profit. To find out, you need accounts and you need them quickly.
The longer you delay after the end of the year before you get your accounts prepared, the less they can tell you about the health of your business. They will be like clues on a trail that you have allowed to go cold.
Perhaps you made a small loss at the end of year one. If you had known this, you would have reviewed every expense and pared it to the bone. You would never have taken on an extra assistant, for instance. Instead, because the records gathered dust untouched for ten months, by the time the accounts are prepared and you know the truth, they are ancient history, and you may be deeply in debt. Men, particularly, have the happy idea that they can 'trade themselves out of debt' - that is, keep going regardless, and hope that things will brighten up. Nine times out of ten, they are headed for bankruptcy.
Look back at the entry for wages. If Sally had prepared her own accounts, she would have included there the £250 a week she took out of the business in the year. This is what she used to live on and to pay her National Insurance. It would be common sense, but it would be wrong.
The wages she paid herself, often called drawings, are not a business expense. That £250 a week did not help Sally earn profits. Drawings are a distribution of the profit that has already been made.
Sally can spend as little or as much out of the business as she fancies and the till can produce, and it has no effect on the amount of profit she has made. She did not earn £13,000 profits (250 x 52 weeks), she made £19,834.
There are certain other payments you will never find in a profit and loss account: the £3,000 Sally paid for the new driers; the £1,000 she spent at the outset to lease the salon. These are capital payments.
Remember at the beginning we talked about the difference between income and capital?  By and large, income payments crop up year after year. Capital payments are a one-off. They are not forgotten. Their place is the balance sheet.
If the profit and loss account is a history of what has happened in the year, the balance sheet is like a snapshot of the business. It shows you just what assets and liabilities you possess on a given day. Table 2 shows Sally's balance sheet.
First, what does the £8,334 represent? The surprising answer is, nothing at all. Both sides must add up to the same figure - they must balance - or else the accounts are wrong. The figure itself means nothing, so forget it.
You will have spotted that the only figure that appears in both the profit and loss account and the balance sheet is profit.
The capital account shows how much the business is worth to Sally. At the beginning of the year, because it was new, it was worth nothing. At the end, it is worth £6,834 to her. Next year £6,834 will be the starting figure. This figure does not mean very much either. The higher the better, of course, but it does not mean that Sally could go out tomorrow and sell her business for this sum.
Because both sides of the balance sheet must always balance, all the assets added together must equal the liabilities. The capital account is a liability of the business because it is what the business owes to Sally.
Looked at another way, the value to Sally of her business is the value of all its assets less the value of all the liabilities to outsiders.
Sally's only liability to outsiders is her creditors. Creditors are people you owe money to, in Sally's case the hire purchase company for her car. She arranged a small overdraft from the bank but she paid it off as soon as she could, to avoid paying interest. You will notice that the £418 interest she did pay is deducted in the profit and loss account. If she still owed the bank money, it would be included among her liabilities.
Sally is lucky. With a cash-only business, she has no worries about debtors. These are people who owe you money, the opposite to creditors. Debtors are assets because when they pay up, this will produce extra money for the business. And if they never pay up? Then the amount of the debt is deducted in the profit and loss account, just like any other business expense.
Businesses with lots of debtors can either pay someone like a debt-collecting agency to try and collect them, or sell their debts altogether. The organization that buys them will pay very little of their original worth unless they rate their own chances of getting the money much higher.
The next chapter will show what Sally's accounts really mean and how she can use them to help run her business and plan her future. This is where the fun begins. But if you have decided by now that self-employment is not for you, and you know all you want to,  skip the next chapter and turn to Chapter 7 to try your luck at getting capital.
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