In owner-managed businesses, for perfectly legitimate tax planning reasons, some of the remuneration paid to directors / managers who also own shares in the company are given to them in the form of dividends rather than as salary.

Although this is sensible from a tax minimisation point of view, it can mean that the actual profitability of the business is significantly over-stated in its management and statutory accounts.

The reason for this is because dividends are not shown in the profit and loss account – they are shown as a distribution of the profit made by the business to its shareholders which will be buried away in the notes of your statutory accounts but not visible on the face of the P&L account.

Take the example of a shareholder / director of a company who, before tax planning, should receive a salary of £50k pa and dividends of £30k – total remuneration of £80k. You tax accountant would probably advise you to take only around £8k of this total remuneration as salary (this is all to do with NI thresholds and maintaining contributions for your state pension) leaving the balance of £72k as dividends. Thus £42k of the "salary" element gets re-designated as dividends and removed from the P&L account – thus increasing the apparent profitablility of the company by this amount. This is misleading.

The solution to this is to prepare adjusted management accounts that show the "commercial salary" payable to each owner / director in the P&L account and thus the correct profit of the business. It is these management accounts on which you should be basing future decisions for the development of your business.

If your company pays increased dividends to some of it's shareholders for tax planning purposes and you don't make this adjustment to your accounts your business will almost certainly be making less profits than your statutory accounts show – consult your accountants so that they can advise on the adjustments you should be making to your figures.