If you’ve looked at your company’s accounts on Companies House and noticed that the figure for capital and reserves has gone down, you may be wondering whether it makes the business look as though it made a loss.
Sometimes it does.
But very often, particularly with micro-companies, that is not what has happened at all.
Your company may actually have had a very profitable year. The reduction in reserves may simply be because you paid more in dividends than the company made in post-tax profit during that particular year.
The difficulty is that anyone looking at Companies House may not be able to see that.
A reduction in reserves is not the same as a trading loss
Here’s a simple example.
Suppose your company makes a profit after corporation tax of £120,000.
During the same year, it pays dividends of £125,000.
Overall, the company’s retained reserves fall by £5,000.
So, if the company started the year with reserves of £80,000, it might finish with reserves of £75,000.
Someone looking at Companies House may simply see:
Capital and reserves last year: £80,000
Capital and reserves this year: £75,000
They may assume the company made a £5,000 loss. But instead the company actually made £120,000 of post-tax profit. And then the shareholders took £125,000 out in dividends.
Can dividends be higher than the profit for the year?
Yes, they can, provided the company has enough accumulated distributable profits available. A company does not have to restrict dividends to the profit earned in that particular accounting year.
For example, your company may have retained profits built up over several previous years.
If it starts the year with substantial reserves, makes £120,000 after tax and then pays £125,000 in dividends, that does not automatically mean the dividends are unlawful.
What matters is whether the company had sufficient distributable reserves available when the dividends were paid.
Why can this look worrying on Companies House?
Micro-company accounts filed publicly at Companies House contain much less information than a full set of accounts.
That means someone looking at the public record may not be able to see:
- your turnover
- your operating profit
- your profit after tax
- how much corporation tax was charged
- how much was paid in dividends
They may simply see the balance sheet and notice that reserves have fallen which can create a misleading impression.
Two companies can look the same but be completely different
Imagine two companies.
The first company genuinely makes a £5,000 trading loss and pays no dividends.
The second company makes £120,000 after tax and pays £125,000 in dividends.
In both cases, reserves would fall by £5,000.
From the limited information visible at Companies House, the two companies may therefore look remarkably similar. But commercially they are in completely different positions.
One has lost money. The other has had a highly profitable year and distributed some of its accumulated profits to its shareholders.
Should you be worried if your reserves have fallen?
Not necessarily.
If your company has made a good profit, has sufficient distributable reserves, can pay its bills and has enough cash for future liabilities, a reduction in reserves may simply reflect how much money has been taken out of the business.
However, it is worth being aware of how the accounts may look to somebody outside the company.
A potential supplier, customer, competitor or lender may look at Companies House and assume that falling reserves mean poor trading.
They may not have enough information to know that the reduction was caused by dividends.
Should you take smaller dividends to make the accounts look better?
Not purely for appearances.
Dividend decisions should be based primarily on the financial position of the company.
That includes:
- cash flow
- corporation tax and VAT liabilities
- future investment
- working capital
- upcoming costs
- available distributable reserves
But if your company regularly pays out most of its profits, or occasionally pays dividends greater than the profit made during the year, it is worth understanding how that affects the public balance sheet.
This can be particularly important if your customers, suppliers or lenders regularly review your Companies House accounts.
The key point
A reduction in capital and reserves does not automatically mean that your company has made a loss.
It may simply mean that more has been paid to shareholders in dividends than was added to reserves from that year’s post-tax profit.
So, if your Companies House accounts appear to show that your business has gone backwards, don’t assume the worst.
However, if you are concerned about how they may look at Companies House, speak to us and we can explain exactly what the figures mean.