Without a doubt the single most common and completely avoidable mistake I see all the…
Considering Which Business Structure? A Closer Look at a Sole Trader
One of the first things to consider when starting a new business is settling on the structure that’s best for you.
Making the right choice from the outset will allow your business to function as you intended and it’ll avoid costly and time-consuming changes down the track. In this article, I’m taking a closer look at Sole Traders.
Like any important decision, an ill-considered choice can have dire consequences. So, learning about the differences between the main business structures and understanding how they apply to your particular circumstances is time well spent.
Operating as a sole trader is the simplest business structure available.
Commencing as a sole trader is as easy as:
- Registering a business name.
- Applying for an Australian Business Number (ABN).
- Opening a business bank account.
Plus exiting is as simple as ceasing to trade.
Unlike companies that are governed by a constitution and other formal rules, sole traders enjoy all the flexibility and freedom that comes with autonomy. This gives the solopreneur the ability to function in a light framework with no protocols that might hinder desired changes in the scope or direction of their business.
With all that independence, however, comes a great deal of responsibility that shouldn’t be overlooked.
Unlike companies who can own property and enter contracts in their own right, sole traders are personally responsible for business loans, leases and other debts accrued for business purposes. It is often difficult for sole traders to distinguish personal funds from business income and a wise business owner will talk with their accountant about the best ways to keep their funds separate and pay expenses from the correct accounts.
Other pitfalls for the sole trader can be:
- Personal assets.
While a company structure limits the liability of its directors, the personal assets of a sole trader can all be at risk if they face legal action. In a worst-case scenario, this exposes the family home and could result in personal bankruptcy.
- Work cover.
With no obligation to register with WorkCover, sole traders must protect their income and make sure they’re adequately insured for work-related injuries.
It’s mandatory to pay superannuation for employees, but sole traders often overlook their own contributions. Left unaddressed, this can make a serious difference to retirement or even an early exit plan.
- Pay as you go (PAYG) tax and instalments.
In the first year of trading many businesses don’t know how much they will turnover, and until you declare how much you’ve earned via your next tax return, the Australian Taxation Office (ATO) won’t ask you to make regular tax instalments.
This might seem like a good thing, but eventually, the tax on your business profit will have to be paid. As difficult as this might be in the early days of business, sole traders must keep track of how much tax they will likely owe, and contribute regularly to a tax account or to the ATO directly.
The real pinch comes when the ATO learns how much you made in your first financial year and also starts to bill you in advance for what it estimates you’ll earn in the following 12 months. This can be a huge shock to an unprepared budget in their second year of business.
- Business Activity Statements (BAS).
Although the formal paperwork for sole traders is minimal, once you register for Goods and Services Tax (GST ) or start paying wages you will need to submit a quarterly BAS.
Choosing a business structure has both financial and legal components to consider, so I asked fellow Smallville contributor and Virtual CFO, Amanda Fisher, what she considers to be significant pros and cons:
“The benefit of operating as a sole trader applies up until your personal marginal rate of tax exceeds the company tax rates. This is an ideal structure for when you’re starting out particularly as there are no establishment costs and no requirement to prepare financial statements.
The downside to operating as a sole trader is there is often a blurred line between business and personal expenses particularly if you’re using one bank account, which I don’t recommend.”
Every entrepreneur should have a solicitor and an accountant they can speak to about their specific circumstances. This is particularly important for a sole trader who is otherwise quite alone in their decision making.
Once you have a good idea of how your business will trade and you’ve learned what you can about the various structures, make a list of questions and talk to your lawyer and accountant to ensure the choice you make is best for you.
“The opinions expressed by Smallville Contributors are their own, not those of www.smallville.com.au"
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