A company’s balance sheet illustrates the financial status of that business at any given point in time. Depending on the size of the company and its industry, accountants might produce a balance sheet monthly, quarterly or annually. This document is critical when it comes to financial planning and accountability. Particularly, if a business ever deals with shareholder loans, the business will be required to keep careful records. A balance sheet can come in handy in these scenarios.
Shareholder loans appear in the liability section of the balance sheet.
What Are Shareholder Loans?
Shareholder loans are essentially just what they sound like – loans from a shareholder or group of shareholders to the company in which they have invested. In most cases, this money is lent under the assumption that interest will be paid when the loan is repaid. Since the loan is not arranged through a commercial bank and is not secured by any sort of collateral, it is considered junior debt, also known as subordinated debt. This type of loan is often associated with S Corporations.
In addition, shareholder loans are common with start-up businesses. With a company that has not yet proven itself and doesn’t have years of financial records to illustrate its credibility as a borrower, it is often easier to take a loan from the company’s shareholders than to seek one out from a commercial bank. Banks are usually more heavily regulated and subject to rules, both internal and imposed by the government.
Cautions When Using Shareholder Loans
Companies relying on shareholder loans should proceed with caution. Failure to repay these loans can have detrimental effects on the business as a whole, since the shareholders hold a major stake in the company. If the shareholders are not repaid the money owed in a timely fashion or with the agreed-upon amount of interest, it can cause significant problems for the business. From a tax perspective, as well, if either the business or the shareholders treat the advance as a debt, and if the shareholder uses the debt basis to absorb flow-through losses, the ultimate repayment of the loan could be subject to capital gains or ordinary income taxes.
In addition, loans of this nature may serve as a bit of a red flag for the IRS, since they are not regulated and can be an easy way for business owners to avoid taking a proper paycheck and thus owing the taxes they should. Careful record keeping to illustrate the legitimacy of the loan and the path the money (and its repayment) have taken are essential.
Balance Sheets and Shareholder Loans
As you might know, a balance sheet illustrates the overall financial health of a company by showing assets, liability and owner’s equity. Assets may be either short- or long-term and can be fixed or liquid (also called current assets). Liability represents all of the money that is owed to an outside party, including debts, accounts payable and the owner or shareholders’ stake in the business.
When you are dealing with shareholder loans, they should appear in the liability section of the balance sheet. It’s essential that this loan be paid back, if possible, by the end of the year, or the shareholder may be liable for tax income equal to that amount.
In some instances, it is possible for a shareholder loan to go the opposite way, that is, be a loan from the business to the shareholder. Though this is not what is normally meant by the term, your company may need to account for such a thing on its balance sheet, too. This type of loan should be tracked on the accounts receivable portion of your balance sheet, classified under assets. When the money is paid back by a shareholder, it would reduce your accounts receivable and increase the owner’s equity section of your balance sheet.