Using the Directors Loan account

Most company’s have got one (some even have several), but unfortunately they tend to be one of the most abused parts of business finances – the Directors Loan account.  Speaking from the other side (when companies have gone into Liquidation), by far the biggest problem Directors have is from overdrawn loan accounts.   The shock is palpable, when you tell a Director that the overdrawn loan account makes him a debtor of the company and it will have to be repaid.  Thankfully, most of the time we can come to a sensible arrangement.

Before we get into how it should be used, to make things easier for you, I would suggest you get a decent bookkeeper, preferably not one attached to your accountant, so you always have two opinions on how to handle something.  A good bookkeeper is worth every penny as they will save you a lot of hassle on your monthly figures and should reduce your accountants fee at the end of the year, as you have such tidy books.

Now I’ve said that, you can get on with ignoring my advice and opting for the rough and ready approach, which is very brave of you – but you’re an entrepreuneur.

Basic Assumptions

OK, I’m going to make some basic assumptions here – you are on a low wage so your NI is paid, additionally you get a dividend payment from the profits of the company. It’s certainly how most Directors of small businesses are paid so I’ll go with that.

Dividends and Corporation Tax

Now to some reading this,  you may feel I’m teaching my granny to suck eggs here, but I’m not, you would be amazed how many times there is confusion over which comes first, Tax or Dividends.  So let’s be really clear:

Dividends available = Annual profit – Taxes.

That’s it – you don’t take the Dividends out and then calculate how much Corporation Tax you pay, I have seen many, very capable Directors, who have made this mistake, and over the years that can really mount up.

The fundamental problem

As you won’t know what your annual profits are until the end your financial year, this means dividends aren’t available to you until then.  You probably don’t have a huge store of cash to live on for that first year.   So what do you live on while you get going – you have all this money coming in, seems almost criminal not to use it for something.

This is where the Directors loan comes into play.   In theory every month you should:

• Calculate your trading profit from the previous month
• Make an allowance for any taxes
• The rest is available for a Directors Loan

So, when you get to the end of the year and the final set of accounts are done, you have already made the allowance for Tax, which, of course, you saved in a separate bank account.

So what about when you’re a bit short?  When starting a new business, cash flow is rarely healthy.  Some months it can just be a battle to keep the lights on.  If you are confident that you have more money coming in next month, then you can use some of your reserves – on the understanding that you will repay it the following month.   If you don’t repay it you can quickly end up with a seriously overdrawn loan account, which will mean additional taxes for the privilege.

Starting a business can be difficult, but with a few simple controls you can make sure that an overdrawn Directors loan account doesn’t have to become one of those problems, while ensuring you keep food on the table at home.