Risks of Small Companies Operating a Current Account
Many small companies – especially family-owned or “owner/operator” businesses – have the same directors and shareholders. In these companies, it is common practice for shareholders to have a “shareholder current account”, also referred to as “drawings”.
The current account is a debt that can be claimed by the Company against the shareholders. While most shareholders do not view their drawings this way, when a liquidator takes over a company, shareholders may suddenly find themselves being pursued for an overdrawn current account.
Calculating the Value?
In practice, the value of the shareholder current account is the net balance of transactions between the Company and the shareholder. When a shareholder injects funds into the Company, this results in a credit in the shareholder’s favour. If the injection is greater than any previous drawings, the Company will owe money to the shareholder, meaning the current account is a liability of the Company. On the other hand, if the shareholder withdraws more money from the Company than he or she puts in, then there will be a debt in favour of the Company. This would be an asset of the Company (so long as the shareholder was able to repay it if required).
It is not unusual for a company to convert all of a shareholder’s drawings into a salary at the end of the financial year. If done correctly, this can “wipe” any outstanding debt. However, directors need to be careful that doing so does not make the Company insolvent. In order to be valid, directors also need to comply with a number of bookkeeping requirements in the Companies Act.
Where is the Current Account?
If you operate a small company, the first suggestion is to check that your company’s current account features in your company’s annual accounts. When it does appear, it is normally listed as a non-current asset (or liability – depending on the balance). However, the current account may simply be included in the shareholders’ equity – meaning it is not always clear what the balance is at a particular point in time.
This can cause problems on two levels. First, because the current account is an asset (or liability, depending on whether you have injected cash) of the Company, directors must consider it when making judgments about the Company’s solvency and its overall value as a business. Second, it means that a shareholder who does not have a clear understanding of the current account may find themselves being pursued for a surprisingly large debt if the Company is liquidated.
The importance of good bookkeeping
Current accounts are a useful way of keeping track of how shareholders are drawing money from a company and ensuring that any money is accounted for, but they can also create problems for shareholders if a company becomes insolvent. In order to protect themselves, directors need to make sure that they keep accurate records and that they are proactive in declaring salaries. Otherwise, the current account can become a major risk for the shareholders.
This article was written by Blair Shepherd for Rotorua Now Magazine.