March 15, 2018 Distributable profits and cash I’m a contractor and a sole shareholder/director of my own limited company. There is currently £20,000 in my limited company bank account but distributable profits in my accounting software are showing as a completely different figure. Can you please explain to me how this could be the case? We hope you enjoy this article from our archives. As tax rules change a lot over time, the information in this post may not be current, but we hope you still find it interesting. Answer, March 2018 A key concept to understand when you are working through your own limited company is that dividends can only be paid if there are sufficient distributable profits. For typical limited company contractors and freelancers, the cumulative post tax profits, less any dividends paid out during the life of the company, will equal the companies distributable profits figure. The distributable profits value is the maximum amount of dividends that can be paid out of the company at that time. It is illegal under company law to pay a dividend if there are not sufficient distributable profits; this is a very important point to understand. The difference between cash held by a company and the distributable profits figure is an important distinction to grasp. There are a host of reasons as to why the cash position of the company and the distributable profits figure would be different, we will discuss a number of the more common reasons in this article. Trade debtors / creditors When a sales invoice is initially raised/sent to a client, before it is paid, it is categorised as a trade debtor on the balance sheet. At this point in time it is considered a sale by the company and the amount of the invoice is a debt owed to the company. This transaction has the effect of increasing the distributable profits of the company without there being any cash movement at all, until the invoice is paid at a later date. Conversely, if you are offered credit by a supplier then when you make a purchase from that supplier the cost of this purchase will be profit affecting, but there will be no change to the cash position of the company until the balance is settled with the supplier at a later date. Corporation tax The current rate of corporation tax in the UK is 19%, therefore when calculating the distributable profits figure a provision should be made for corporation tax. Some accounting software will do this automatically but you may need to make a manual entry for this. For example, if the only transaction a company has undertaken has been sales of £10,000 and assuming this amount has been paid to the company, then despite there being the full £10,000 in the company bank account the distributable profits figure would only be £8,100 (being £10,000 less the £1,900 corporation tax provision). Timing differences Accounts for limited companies must to be prepared on an accruals basis to comply with the relevant legislation, as such expenses and income need to be matched to the accounting year that they relate to. For example, if a company pays its rent for the next 12 months a few days before its year end there should be an accounting adjustment to move this cost to the following year. This adjustment in isolation would have the effect of increasing the retained profits figure by the rental charge despite the cash position of the company having worsened. We have a separate blog article about timing differences here. Directors loans There are occasions during the life of the company where a director may not take the full amount they are owed by the company. This may be due to dividends voted but not taken as cash, or expenses claimed but not yet repaid. In this instance although the distributable profits will be depleted by the amount of the dividend or expense, the cash position of the company will remain unchanged. The opposite is true where the director borrows cash from the company – although borrowing from the company has other tax affects which are discussed in more detail here. VAT As with corporation tax, VAT can have the effect of exaggerating the difference between the cash held by a company and the distributable profits position. Where a company is VAT registered they must charge VAT on relevant sales – this is likely to be all sales for most contractors working with UK clients. As such where an invoice of £10,000 is issued to a client, a further 20% of VAT will need to be added, making the total invoice £12,000. At the time this is paid, and ignoring any corporation tax provision, the company will have £12,000 in the bank but the sales / profit figure on this amount will be £10,000 – with £2,000 owed to HMRC in the form of VAT. The above are just some of the typical examples of why a limited company’s distributable profits will differ to the companies cash balance. At JF Financial we highly recommend FreeAgent for freelancers and contractors. This online book-keeping system does a great job at keeping your distributable profit up to date so you know the amount of dividends that you can take out of the business.