Salary, dividends and retained profit: the words a lender will ask about

Nobody starts a business in order to learn accounting vocabulary. So it is entirely normal to run a perfectly good company for years and still not be certain what somebody means when they ask about your retained profit.

This is a plain-English glossary of the terms that come up when a lender looks at a director's or a sole trader's income. What each one means, where it appears, and why anybody cares.

Salary

Your salary is what the company pays you as an employee of it. It appears on a payslip and in the company's payroll records.

Many directors take a modest salary, for reasons that made sense when their accountant set it up. That is ordinary and it is not a problem. It does mean that a payslip on its own tells a small part of the story, which is why nobody stops there.

Dividends

A dividend is a distribution of the company's profit to its shareholders. It is not a wage, and that distinction matters more than it sounds.

Because they come out of profit, dividends are irregular by nature: they depend on the company having made money and on a decision to distribute it. They appear in the company's records and on your personal tax return.

Retained profit

Retained profit is profit the company has made and not distributed. It has stayed in the business.

This is the term people find hardest, partly because it feels like it should not count. From your point of view the money did not arrive in your account. From a lender's point of view, it is profit your business generated, and some lenders may take a view on it.

That is why the same director can be described in two quite different ways depending on who is looking.

Drawings

Here is where a genuine confusion sits, and it causes real problems.

For a sole trader, drawings are simply money taken out of the business for personal use. There is no legal separation between you and the business, so it is a straightforward withdrawal.

For a limited company director, the word gets used loosely to mean money taken out, but the company is a separate legal entity, so what looks like a drawing is usually salary, a dividend, or a loan to a director, each of which is treated differently.

If you and your accountant mean different things by the word, that will surface at exactly the wrong moment.

Net profit before tax

For a sole trader, this is the line most likely to be looked at: what the business earned after its costs and before tax.

It is not the same as what you took out, and it is not the same as turnover. Turnover is what came in; profit is what was left.

SA302 and the tax year overview

Two documents, both from HMRC, and people frequently mix them up.

The tax calculation, still widely called an SA302, sets out how your tax was worked out from what you declared. The tax year overview shows what HMRC has on record as due and paid.

Lenders often want both, because together they show what you declared and that it tallies with HMRC's own record. We are not going to print step-by-step instructions for downloading them, because the process changes and out-of-date instructions are worse than none. If you need them, ask and we will point you at the current route.

Why all this matters

Look back at that list. Salary, dividends, retained profit, drawings, net profit. Those are five different ways of describing one person's income, and they can produce five different numbers for the same year.

Which of them a lender leans on is the single biggest reason two people can look at your accounts and reach different conclusions. It is also the reason this is worth a conversation rather than a form.

JB Partners sits alongside MCC Partners, a firm of accountants, so the person reading your accounts reads accounts for a living. That is the whole of the claim we would make about it.

What this article is not

It is a glossary, not advice. You will find nothing here about which income structure is preferable, or what to leave in the company, because that depends entirely on your circumstances and it is a question for an accountant rather than a broker's blog.

If you want to know what these words mean for your own figures, the initial consultation is free of charge and without obligation. We are in Gravesend.

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