A director’s loan allows business owners to access money from their company to help manage short-term issues, such as cash flow problems.

While this can be useful, it’s important to understand how it affects your business finances because it can have a profound effect if it is not managed properly.

How does a director’s loan work?

A director’s loan gives business owners the ability to borrow money from their company and if managed meticulously, can offer flexibility and help resolve immediate financial concerns.

You might choose to take a loan for different reasons, such as dealing with temporary cash shortages or taking advantage of a personal investment opportunity. Using internal funds also means there’s no need to apply for bank loans or other external finance options.

In addition to this, if repaid within the timeframe set by HM Revenue and Customs (HMRC), a director’s loan can be tax-free.

There are other benefits too, including that a credit check isn’t required and if interest is charged, it may be tax-deductible for the company.

However, despite being an internal transaction, a formal loan agreement is still necessary.

The loan must also be properly recorded in your company’s accounts to make sure everything is in order when filing with HMRC.

What effect can a director’s loan have on your business?

The main point to remember is that the money taken through a director’s loan is leaving your business, meaning your potential revenue and profit figures will be affected.

Should you take out a director’s loan, you are personally responsible for repaying the loan to the company.

Repayment terms are set out in the Corporation Tax Act 2010, which clarifies that if the loan isn’t paid back on time, there are tax consequences.

The repayment must be made within nine months and one day of the company’s financial year-end. If not, the company will have to pay additional tax, known as S455 tax, at a rate of 33.75% on the outstanding loan amount.

Missing the repayment deadline could also damage your company’s financial standing. It will appear on the balance sheet, which can affect your ability to borrow from lenders. It may also put off investors or potential buyers, which could make it harder to sell or grow the business in future leaving you to assess your own exit plans.

Why you should speak to an accountant

Before deciding to take a director’s loan, you should be sure it’s the right solution. While it might help in the short term, it can create problems that really impact your business

You need to look at all the options available to you before deciding to take a director’s loan and this is where an accountant can help.

Our experienced team can help you review both your personal finances and the company’s financial position to spot opportunities to avoid a director’s loan because they should be considered as a last resort.

You’ll receive clear advice, tailored to your needs so you can make the right decisions to help ease your concerns and protect your business.

If you have any financial questions or need support, contact our team today.