Your company is either tax-friendly or credit-friendly whether you’ve thought about it or not. The distinction has a huge impact on the process of obtaining financing, so it is helpful to understand where your company stands.
Is your company tax-friendly or credit-friendly? What are the differences and why do they matter?
If you, as the business owner, take most of the money out of the company (through receiving dividends) your company will not show a great profit. This is perfectly legitimate and is the general practice for those who are trying to reduce tax costs.
If your business fits into this category, the following applies:
- High-risk borrower – A lender will not see a tangible net worth in your company, so will consider you “high risk” because they don’t know if you’ll be able to pay back the money they are going to lend you.
- Co-signer required – It is very likely that a lender will require a co-signer on a financing agreement to give them greater security. (See What You Need To Know About Co-Signing.)
- Low taxes – Because your company’s profits are low, you will pay lower taxes.
When profits are left in the company, your business shows a higher net worth. This is attractive to lenders.
- Lower-risk borrower – Because a lender can see that the company is making money and already has a healthy net worth, their risk is low.
- Co-signing most likely not required – When the risk to the lender is low, it is unlikely that they will require a co-signer to secure the financial agreement. (See What You Need To Know About Co-Signing.)
- Higher taxes – The greater your profits and net worth, the more taxes you will have to pay.
Which One Are You?
There is no right or wrong option here. There are clear pros and cons of each. Have a conversation with your accountant to help you determine what is best for you and your business.