One of the first things a small business should educate themselves on is payment-related processes. Doing things wrong in the beginning means penalties, fees, and failed audits. That’s why, when making payments out of a business, it’s important to understand every which way the cash flows.
Effective cash management starts with knowing the difference between disbursements and payments (reimbursements) and when to make them.
What is Disbursement?
Disbursement–or payment disbursement–is the delivery of payment from a business’s bank account to a third party’s bank account. Disbursement refers to a range of payment types, including cash, electronic funds transfer, checks and more. All disbursements are recorded to show how a business spends money over time.
Cash disbursements measure the amount of money that’s actually flowing out of a company, which may be very different from the company’s profit or loss. It’s a form of payment from a public or dedicated fund on behalf of a client to a third party, where reimbursement is subsequently sought. In general, disbursement is a term that describes the spending and distribution of money from a financial institution.
A disbursement voucher (DV) is a form that is submitted to have a check prepared for payment. This money is then used to pay an organization or individual for goods or services rendered. A DV can have multiple payees depending on what debt is being settled. These payments are generally made through clearing/deposit bank accounts. The voucher then gets filed with financial statements.
In a business sense, the term “disbursement” refers to a method of payment for many types of transactions. It does not have to be a specific payable. When writing a check from a business account, referring to the payment as a disbursement check is usually appropriate. This term is never used for personal finance.
A company can create disbursement checks for a multitude of payment types including:
- Employee salaries
- Payroll expenses
- Payments to suppliers, contractors, and vendors
- Reimbursements to workers for out-of-pocket expenses
- Dividend payments to shareholders
- Profit distributions to other business owners
Cash disbursements (also called cash payments) are made by a business during a specific period (like a quarter or year). It’s the cash outflow from a company to settle obligations like operating expenses, interest payments, and accounts receivables.
There are several payment options for cash disbursements that includes cash, checks, or electronic fund transfers (EFT). If you’re using a check, there is typically a delay before the funds are withdrawn. It’s only a few days but is necessary due to mail and processing float.
A cash disbursement can also be used to refund a customer. This is recorded as a reduction of sales. Another kind is a dividend payment and is recorded as a reduction in corporate equity.
Cash disbursements are usually made through the accounts payable system, but funds can also be disbursed through petty cash or payroll. Each entry on your records should include the amount, date, payment method, and purpose of the transaction.
This entire process can be outsourced to a bank. They will issue payments on the dates authorized by the paying entity, using the funds in that entity’s checking or savings account.
This is a technique generally used in corporate cash management. It helps larger companies monitor and structure their payments while benefiting (as much as possible) from earned interest.
Controlled disbursement regulates the flow of checks through the banking system on a daily basis. This is done by mandating once-a-day distributions of checks. This is process happens early in the day to meet certain investment and fund management goals.
Disbursements vs. Payments
Disbursement of funds is not the same as reimbursement. The term “reimbursement” refers to the payment refunded for the original disbursement.
When a business sends a disbursement on behalf of a client, the reimbursement is what the client pays to the company as a refund for the original payment. Reimbursement can involve discounts or interest fees, depending on the contract.
In general, the difference between a payment and disbursement is that one is the instance or process of disbursing while the other is the act of paying. From the VAT point of view, the two systems are significantly different. That’s because payments are subject to VAT, while disbursements are not.
It should be noted that if an organization is trading close to the VAT registration threshold, the wrong classification of expenses might lead to the VAT registration gateway being breached.
In order to treat a payment as a disbursement, it should meet several criteria. The following must apply:
- You had permission from the client to pay for them.
- The client received, used, or had the benefit of the goods/services you paid for (for them).
- You paid the supplier on your client’s behalf (acting as the agent of your client).
- The client knew the goods/services were from another supplier—not from you.
- You breakdown the costs separately on an invoice
- It was the client’s responsibility to pay for the goods/services—not yours.
- You pass on the exact amount to the client when you invoice them.
- The goods/services you paid for are in addition to the cost of your own.
One prime example of disbursement would be a solicitor paying the stamp duty land tax (SDLT) on behalf of a client. This is obviously a client’s expense. The SDLT is the buyer’s responsibility, not yours.
A student loan is also another form of a payout. It’s called a loan disbursement. When it comes to financial aid, the payment of money comes from the source of aid (school, government, private lender, etc.), and in most cases, it is paid directly to the school.
An example of simple payments or reimbursement would be the cost of travel, eating out, office supplies, or other out of pocket expenses added by a consultant/contractor. As a result, VAT should be included, as these expenses represent costs that the business incurs for itself. They cannot be considered disbursements.
The key consideration between disbursement payments vs. payments is whether the expense belongs to you or your customer. It’s important to get it right. Otherwise, your business could be penalized when audited. It’s also the primary way to ensure employees are paid properly and the taxes align correctly.