Businesses invest using shareholder loans, especially businesses managed by primary shareholders or have active relationships with several major shareholders even though they are not corporations. Shareholder loans help companies bridge difficult times or cover operations for a particular month when cash is tied up elsewhere. Because shareholders own a stake in the business and often a better understanding of it than outsiders, primary shareholders may be more willing to make these loans than outside parties, although accounting practices can be similar.
To versus From
Loans from shareholders differ from loans to shareholders in several key ways. When a business is privately owned, owners may siphon money from the business and use it for personal reasons, an act that is often considered a loan to a shareholder and falls under specific tax laws. However, a loan from a shareholder incurs more basic regulations and accountants treat them much like a loan from a bank or other party that does not have an immediate interest in the business.
On the balance sheet, accountants calculate liabilities along with equity to match all the assets a business has. While a shareholder loan may count as cash on the asset side of the balance sheet, it is a liability on the other side, because the business must pay the loan back, usually at a particular interest rate. Equity, although counted with liabilities, does not obligate the business to pay back money as a loan does, so accountants separate the shareholder from the money the shareholder used to buy stock in the first place.
In the balance sheet, businesses should keep separate accounts for all liabilities. Most businesses keep an account solely for shareholder loans that they have received. Accountants can then easily differentiate these loans from shareholder loans they have given out, and from dividends and other monies that the business pays out to shareholders for different reasons. The shareholder loan account falls among other similar liabilities and accountants include it as a part of the long-term debt of a business.
Businesses sometimes struggle defining loans from shareholders clearly. In some cases, if the contract between the shareholder and business does not specify its conditions, the loan may legally qualify as equity. This occurs if the parties do not specifically state a payment plan or if accountants do not correctly record the loan as a liability on the balance sheet. Businesses should make sure that the shareholder loan qualifies as a bona fide debt according to regulations so that the IRS or other legal bodies do not count it as equity.