Dividends in Xero
In this post we are going to explain how you can use Xero to see how much dividends you are able to pay yourself.
For a dividend to be legal it needs to be paid out of company profits, if you have never made a profit you will not be able to pay a dividend. You can read more about this on our blog post ‘How to avoid paying illegal dividends’.
Our preferred simple method for working out available dividends
When new clients sign up to us we always tell them a simple formula for working out how much dividends to pay. For a contractor, this is normally something like:
Set aside 35% of the cash you have coming in from your clients to cover tax payments (VAT and Corporation Tax). Then you can take out your monthly salary, whatever is then left can be taken as dividends.
This method doesn’t work for everyone though so if your finances are more complicated you can follow the Balance Sheet approach below.
Using the Balance Sheet in Xero instead
The best place to see how much money you can set aside for dividends is on the Balance Sheet report. To get that in Xero just go Reports > Balance Sheet and it should show you the current balances. Here is an example Balance Sheet:
We want to focus on the bottom section, the ‘Total Equity’.
Understanding the Total Equity section
There are four lines here:
Capital – This is the value of the original shares and investment in the company. When we incorporate company’s for clients we normally make this £1.
Current Year Earnings – This is your net profit (sales less expenses) that you have earned since the start of your company’s financial year.
Dividends Declared – This account tracks the total dividends that have ever been paid from the company. In this Balance Sheet above, the owner has withdrawn dividends totalling £11,000 since starting the company.
Retained Earnings – Retained earnings are all the profits earned in previous years. So if the Current Year Earnings figure was to stay £22,522 up to the end of the year (ie if there was no more trading), then come the new year the £22,522 of ‘current year earnings’ would be added on to the Retained Earnings of -£67 to result in a new Retained Earnings balance of £22,455.
The Dividend Calculation
To work out the available profits available to distribute you just have to calculate Current Year Earnings less Retained Earnings less Dividends Declared. Your answer should be the same as Total Equity less Capital.
One final consideration you need to make is whether you owe any Corporation Tax that hasn’t yet been included in the accounts. If that is the case you can take your Current Year Earnings and multiply it by 20% (the corporation tax rate). In the above example that would be £22,522 x 20% = £4,504.
So our final calculation for dividends available is:
Current Year Earnings – £22,522
Plus Retained Earnings – (£67)
Less Dividends Declared – £11,000
Less Corporation Tax on Current Year Earnings – £4,504
Available Dividends = £6,951
If you ever struggle working this out do please get in contact with your Caprica Accountant and they will be happy to help you out.