It's a familiar story.
You have a great idea, and decide to go into business. Starting out for the first time, and unsure how it will go, you set yourself up as a sole trader. A friend recommends that you jump on Xero as it's easy to use - so you find a Xero expert and get set up. You have the world at your feet.
Over time, your business grows and thrives - after all, you're good at what you do. So you make the decision to transition to a company structure. One item on your action list is converting Xero across - and what happens next is important to get right.
What not to do
Lately at Digit, we've come across a few cases of how not to change over to a company in Xero. What people have done is simply change the ABN to the new registered company, change the dropdown in Xero for organisation type to Company', and away they go. It's simple, right?
Not quite
As far as the ATO is concerned - even if you're trading under the same name, you as a sole trader' and you as a company' are completely independent and unrelated entities. Like two strangers walking past each other in the street.
For business activity purposes this is especially true - your company would lodge a tax return, and so would you as a person. If you're registered for GST - you would lodge a BAS, and so would your company. If you have employees, they would need to sign new agreements with the company. What's owned by you as a sole trader - needs to be transferred to the company in some way, if you so choose it.
The shortcut sometimes taken is to say - well you registered the company as at February 10th, so all activity in Xero before that is for you as a sole trader, everything after is you as a company, and we'll do a few adjustments to balance it all out. We'll manually lodge a BAS for Jan-9 Feb, and another from 10 Feb to 30 Mar. This way you have your full history in one Xero account.
The problem with this approach - is that the transition from a sole trader to a company is rarely so clean.
Typically, activity continues in the sole trader account for some time after the changeover. Whether it's customers paying the wrong account, or suppliers debiting it. Add to this the fact that the context is wrong - the trading history of you as a sole trader isn't related to your performance as a company.
So what is best practice for managing this transition in Xero?
The best approach to take is the simplest. Set up a new Xero account for the company, and over time change over from one to the other. We've put together a quick checklist for making the change from sole trader to a company -
- Create a new Xero account as at the incorporation date of the company
- Set up new bank accounts under the company, and get the feeds up and running
- Let your clients and suppliers know that the company details have changed
- Clear your balance sheet as a sole trader. Talk to your accountant and find out the best way to manage any assets still held by you as a sole trader (such as money in your bank accounts) and also any liabilities (such as loans). For instance - money in your sole trader account might be treated as funds introduced to your company
- Continue lodging any Business Activity Statements for both you as a sole trader and you as a company for as long as there is activity in those entities during the reporting periods
- Close down the sole trader bank accounts - exporting out any CSVs or bank statements
- Downgrade the sole trader account to a ledger (you can upgrade it again if you ever need to access the financials - such as at year end)
By doing it this way - there is a clear distinction between you as a sole trader, and the company. Both can still have activity during the changeover period without it becoming unnecessarily messy - and it ensures that the process of moving from a sole trader to a company is as smooth and easy as possible.
