The problem of the overdrawn director’s loan account

The use of a limited liability company is now considered the normal way to be in business. It is not often that entrepreneurs trade in their own name or in partnership.

A limited company distances the entrepreneur from the business if things go wrong, and the company itself is considered to be a separate legal entity. That’s fine when the entrepreneur can distinguish in their own mind what belongs to the company and what belongs to the individual, but it all gets confusing and messy when that division breaks down and by far the biggest problem is cash withdrawals from the company by the director.

Directors will be familiar with the directors loan account, which shows what money the director has lent to the company and what has been repaid. Also added to that loan account is any other monies paid to the director or for the director for personal goods and services.

There is usually no problem where the loan account remains in credit, but when it becomes overdrawn the problems can start.

Directors are often advised to use their loan account to reduce the tax bill, especially when times are hard and cashflow is poor. These tougher times can get worse and in the very worst cases lead to insolvency.

If the business fails, not only does the director lose their business, there may be personal guarantees to repay, and to add insult to injury the insolvency practitioner appointed will be inviting the director to repay their overdrawn loan account.

The usual reaction from directors is a stunned silence, and they simply can’t understand that it isn’t their money. They then blame their accountant who advised them to do this ‘to save tax’. The reality then dawns on them , and arrangements have to be made to repay the loan at a time when personal funds are scarce.