Taking out cash for Directors vs Sole Traders

As a business owner, it's important to consider the most efficient and effective ways to manage your finances. One aspect of this is the decision of how and when to take out cash from your business.

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Managing your finances can differ greatly between directors and sole traders. If you’ve just moved from being a sole trader to a director, you may get caught out when withdrawing cash from the business. The rules are different but don't worry, we are here to help.

In this blog, we'll explore the differences between taking out cash for directors versus sole traders.

First, it's important to understand the key differences between these two types of business owners.

The difference between a Director and a Sole Trader

A director is a member of a company's board of directors, who is responsible for managing the company's affairs and making decisions about its operations. In contrast, a sole trader is a self-employed individual who is the sole owner of their business and is responsible for all aspects of its operation.

Why are the rules different for directors and sole traders?

When you’re a sole trader, you and your business are one and the same legal entity. So taking cash out is a simple procedure. But as the director and shareholder of a limited company, you and your business are two separate entities – and that means that money in the business is no longer your personal money. It’s money that belongs to the limited company.  So when it comes to taking out cash from the business, the process is typically more structured and formal.

How do I draw money out as a sole trader?

Sole traders have more flexibility when it comes to taking out cash from their business. As the sole owner of their business, they can take out money as and when they need it. However, it's important to note that any money taken out of the business is considered to be personal income and is subject to income tax and National Insurance contributions.

How do I draw money out as a limited company director?

For a limited company, it’s a legal requirement to have a separate business bank account. Even if you own the company 100%, the money in the company bank account belongs to the company, it does not belong to you. So, how do you take out money to live on? There are four ways of taking money out of the limited company, and in each case you should do it by transferring funds from the company account to your personal account. Preferably you should make these separate transfers, even if they happen on the same day.

• Claiming back your expenses – any business expenses that you’ve paid personally can be reclaimed. Your expense claim should include receipts or other documentation, and a description of what they were for.

• Being paid a salary – you can opt to be paid a salary for your role. This salary is processed through your payroll system, with any PAYE and NI deducted. The net pay due should be transferred to you on the normal company payday.

• Withdrawing a dividend – where there are sufficient after-tax profits available in the company, you can withdraw dividends. Paying yourself and your fellow directors a dividend requires some formalities, including board minutes and dividend vouchers.

• Directors’ loans and repayments – if you’ve previously loaned money to the company, the loan can be repaid to you. Where nothing is due, the company can lend you money but there may be interest charged (or a taxable benefit may arise if no interest is paid). The company may also be liable for a 33.75% temporary tax charge (section 455 charge) if the loan is not repaid by the end of your company’s financial year.

In summary, taking out cash for directors and sole traders is a decision that should be carefully considered based on the individual circumstances of each business. Directors typically have a more structured and formal process for taking out cash, whereas sole traders have more flexibility but need to be mindful of the impact on the business's finances. Ultimately, the key is to find a balance that allows for personal financial needs while also ensuring the long-term success of the business.

Withdrawing funds from your company for personal use takes some serious thought and planning. If not, you may well end up with an unintended overdrawn director’s loan account. 

It’s important to remember that the company’s funds are not yours in the same way that a sole trader owns the funds in their business account. Getting professional advice as a director is the best way to manage your cash withdrawals from the business. We’ll work with you to:

• Decide the best split between salaries and dividends 

• Help with any board minutes and other documentation 

• Help ensure that your company’s bookkeeping records accurately and timeously reflect the movement of funds between you and the company.

So get in touch today to find out how we can help you!