What is a Directors Loan Account?
Posted on 26th Apr 2022
Have you ever wondered what is a directors loan account?
Have you ever wondered what a directors loan account is and what goes through it?
In this video Kim will explain all!
WHAT IS A DIRECTORS LOAN ACCOUNT ?
Have you ever wondered what a directors loan account is, and what goes through it, OR, are you confused by what it’s all about – as a small business owner? If so, you’re not on your own. Watch this video to learn more. We’ll go through the main types of income and expenditure going through it and what to do to ensure you don’t end up owing the company money!
I’m Kim Marlor from Krystal Clear Accounting, and I find that Director’s Loan Accounts are one of the things that small business owners find hard to fully understand.
When we’re meeting with clients to discuss their annual accounts and future growth plans, one schedule business owners get really interested in is a Director’s Loan Account. Most people actually don’t really understand it. So let’s look at all of the different areas.
So, what is it?
Every limited company is a separate legal entity. So, in essence, it’s effectively like it’s a separate person, not you. So, you as the director and the owner are separate from your company. So, what you owe the company, or the company owes you is recorded in the Director’s Loan Account. So, in basic terms, all of the ins and outs between you and the company are recorded in this account.
Money INTO the Directors Loan Account
So, let’s start with this.
What types of income could be going into the Director’s Loan Account? Well, it could be your Salary, especially in the beginning when there may not be the cash to pay it. So, it would be the net pay that’s been declared from your payslips (The amount after taking off Income Tax & National Insurance Contributions) and the returns that have been declared to HMRC.
The next one would be dividends. So, any dividends that have been declared that can be put into your loan account, they don’t have to be paid out immediately or at all. You might be declaring them to pay off a previous overdrawn loan account balance, OR you may decide you don’t need to take the money out at that point in time. So, the dividend goes into your loan account as a distribution as money that’s owed to you. You may want to leave it in to finance working capital.
Another payment into your loan account could be expenses. Very often, we pay for expenses out of our own pocket, and if they are wholly and exclusively and necessarily in the course of business, then THEY are allowable for tax purposes as well. So, this could be a coffee with a prospective customer. Therefore, this money is due back to you. It could also be mileage for business travel.
Another Money In could be Interest on your loan account for credit balances, i.e., if the company owes you. So, if you have lots of money owed to you, sitting in your directors’ loan account, you can, if you wish nominate that you charge interest on that balance at a commercial rate. That interest, though, will need to go on your self-assessment Tax Return. Note, sometimes it can be a great tax planning tool, but you need to look at everything in total i.e., all of your affairs before you do this, and of course seek advice from your Accountant.
Now let’s look at Money going out of your directors Loan Account
Now, this is an often an interesting area and one that causes a lot of concern as people often get confused especially if they have had a sole trader business previously!
Money out of the directors’ loan account is everything that you’ve taken out of the business, and it could be taken out in several ways.
- petty cash,
- Cheques – although not so popular these days!
- Bacs transfer for example.
If you’ve taken money out of the business, it will be money out of your Director’s Loan Account.
Or, and this is an area people get confused with, that you have used business money to pay for a personal expense.
So, the Directors Loan account is the balance, the net of, all the ins and outs.
As I’ve said, this is where it sometimes gets a little confusing for people, especially if they’d taken out more than they realised a little bit here and there, and it all adds up. And if you’re not keeping a tight watchful eye over it, it can come as a shock how large the balance is.
The balance will either be you owe the company, and it’s an overdrawn loan account, or the company owes you and you have a positive balance.
I’d advise being really careful.
It’s all too easy to get your company card out and use it to buy stuff for personal consumption, And before you know it, you owe the company a fair bit!!!!.
This is not the way to run your company in a professional manner and HMRC DO NOT LIKE IT!!!
What we advise at Krystal-Clear Accounting, is that business owners sit down and plan first….pull together a financial plan which shows what profit you want to extract to live your “ideal life” and then work it backwards to overheads, Gross Margin, costs of sales, turnover and what that actually looks like in terms of numbers of sales by product or service we can even take it right up to numbers of leads and new customers required.
That way you know exactly what you need to achieve every week or month in order to be able to take the money out of the business that you need. What we often see, is prospective clients coming to us, having an overdrawn loan account without understanding the implications, needing a certain amount of money to live on, which the business model cannot support and they find themselves in a vicious cycle of owing the company money and even worse the tax man. It can be very stressful not being able to pay the bills and hard to get out of the cycle!
So, if you don’t know the balance on your Directors loan account then I would advocate you find out, check your cloud accounting software and ask the question of your advisor. It is really important that you understand how much money you need to live your life and set up a robust process so it’s controlled. If you’re out of control, you could, as I’ve already said, rack up a load of drawings, which there may not be the available profits to clear, especially important when times are tough.
Much better to plan everything and control the way you pay yourself, rather than doing it ad hockly. I know most business owners want to be as tax efficient as they can be, but sometimes for peace of mind it might be better to pay yourself a salary, but you need to discuss this with your Accountant!
I often hear people say they take a low tax efficient salary and then the rest in dividends every month…..HMRC can take a dim view of monthly dividends as they see this as disguised salary where you may be trying to avoid paying tax….especially if there are no retained earnings in the business with which to declare what we call a “legal dividend”. Either way, it is vitally important that you know your numbers, know how your business is doing before taking money and hence NOT taking money AD Hockly.
What happens if you have got an overdrawn loan account?
If your Director’s Loan Account is overdrawn, which means you owe the company and you haven’t got the means to reimburse it, then you can be hit by HMRC with a tax for overdrawn Director’s Loan Account, which currently is 32.5%, quite a hefty amount.
Also, if you have an overdrawn loan account, it can be classed as a business benefit in kind unless the business is charging you interest. Do not fall into this trap. It’s a really bad habit and it’s something that’s very difficult to get out of . And also, it’s often hiding a bigger business problem in your business.
Here at Krystal-clear we are massive fans of planning. So, we have different planning packages, and every client has a getting started meeting to plan what they need to take out of their business to live their life.
If you have a proper financial model and plan fully, you know what your turnover and profit figure needs to be. It’s most important to plan your business and personal costs and income. And while stuff will always get in the way and change, you at least know what you’re aiming for. It’s much better to go into business with your eyes wide open, that way you are more likely to make a massive success of it.
If you haven’t planned for your business success, maybe now is the perfect time so you can really drive your business forward, get a handle on all the costs and eliminate any that are not required. You might be surprised by exactly where your money is going and be able to plan for more pleasant expenditure items like holidays, taking the family out on days to create memories, buying a new house, maybe, or even extending or improving, or a whole heap of other stuff. Or at the very least avoid sleepless nights worrying over how to pay back an overdrawn loan account!!! (THIS was not filmed)
If you’d like to have a chat over a coffee (Virtually or face to face) and to see what is possible, all you need to do is call me or one of my team on 0161 410 0020 or email email@example.com
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