An introduction to dividends

This article provides a brief introduction to what dividends are and how to record them in FreeAgent.

Before recording a dividend in FreeAgent, it’s important to understand what a dividend is and when a company can pay a dividend.

It's also important to remember that if you're employed by a company, the money the company earns in sales revenue belongs to the company, not to you personally. That applies even if you're the only director and only shareholder in the company.

What are dividends?

Dividends are sums of money that limited companies pay out to people or other companies who own shares in the company. These individuals and companies are known as shareholders.

If there are multiple shareholders, the dividends typically match the company's share split, unless either the company has issued different classes of shares on which it pays different dividends, or any shareholders have waived their entitlement to dividends.

If a director of the company is also a shareholder, then a dividend is one of three ways that a limited company director can take money out of the company, the others being a salary for the work they do as an employee or director, and the company paying them back money that it owes to them (director's loan).

Dividends count towards a director’s income for personal tax, so keep this in mind as your dividend income may contribute to your total income breaching the £100,000 income threshold, which would result in the tax-free personal allowance being gradually withdrawn. The dividend income could also contribute to potentially losing out on child care allowance and having to pay High Income Child Benefit Charge (if your total income goes over £60,000). 

If you’re unsure whether the company is able to pay you a dividend, please speak to your accountant. If you’re not currently working with an accountant, you may wish to find one through FreeAgent CoPilot.

When can a company pay a dividend?

Limited companies are only allowed to pay dividends if they have enough profit available to do so. The profit that the dividend is paid from can be from this current year or from a previous year.

It's important to remember that profit, which is the amount that your business has left over once its allowable day-to-day running costs and Corporation Tax have been subtracted from its income, is not the same as cash in the bank. There are non-cash items which may affect your profit, such as depreciation of capital assets.

Therefore, before you pay a dividend, it's important to check your Profit and Loss report in FreeAgent to make sure that you have enough profit available after tax. The 'Carried forward / distributable' figure which you can also find in the mini 'Profit And Loss' widget on the Overview screen, is a good pointer here. Please double-check these figures with your accountant before the company pays a dividend, as the Corporation Tax figure here is an estimate and may be different from the final amount due.

Even if the company has enough cash to pay the dividend, it is illegal for the dividend to be paid if there is no available profit this year or profit held over from a previous year. If you take out more than is legally available, there may be extra tax to pay. If you’re unsure whether the company is able to pay you a dividend, please speak to your accountant.

In the picture below, you can see this company has paid illegal dividends because the 'Dividends' figure of £100 is higher than the 'Carried forward/distributable' figure of -£1,451.

How to record a dividend

Whenever a company plans to pay a dividend, the directors must, by law, have a board meeting first to check that there is enough profit available before they allow a dividend to be paid. Allowing a dividend to be paid is called ‘declaring’ a dividend and the board of directors must produce board minutes (even if the company has only one director) and the necessary paperwork, in the form of dividend vouchers.

Every time you record a dividend in FreeAgent, it will automatically create the minutes and vouchers for you. Once the voucher and relevant board minutes have been created, you need to print them out, fill in the gaps in the minutes or add the voucher to your existing meeting minutes, have them signed by the chairperson and keep them safely.

There are two ways to record a dividend in FreeAgent, which are only available in the UK limited company account type.

If the dividend payment has already been paid out of the business bank account or will be immediately, you would explain the bank transaction as a dividend payment once it has imported into FreeAgent via your bank feed or uploaded from a bank statement.

Alternatively, if the dividend has been declared but hasn't been paid out of your bank account yet and won’t be immediately, you would post a dividend journal set in FreeAgent.

If you’re unsure how to record the dividend in FreeAgent, please speak to your accountant.