Loan repayments in Xero: why they are not on your Profit and Loss, and how to record them

Short answer: a loan repayment is two things in one payment. The interest is a cost of borrowing, so it goes to an expense account (such as Interest Expense) and shows on the Profit and Loss. The rest, the principal, is you paying back money you were lent: it reduces the loan, which is a liability on the Balance Sheet, so it never appears on the Profit and Loss. The same goes for the day the loan arrived: the money in the bank was not income, it was a debt. That is why a business repaying $1,245 a month can see only about $400 of it in its expenses, and why the bank balance can fall while profit looks fine.

In Xero you set this up once: a liability account for the loan, then each repayment split between that account and Interest Expense, checked against the lender’s statement. Menu names move between Xero releases; if a label below does not match your screen, search Xero Central for “record a loan”.

What goes where

	Profit and Loss	Balance Sheet	Bank
Loan paid into your account	Nothing	Loan (liability) goes up	Up
Interest in each repayment	Interest Expense	Nothing more	Down
Principal in each repayment	Nothing	Loan goes down	Down
Lender’s fees	An expense, such as bank fees	Nothing more	Down
Equipment bought with the loan	Only depreciation, over the years	Fixed asset goes up	Down when you pay

So the Profit and Loss tells you what the loan costs you (the interest and fees), and the Balance Sheet tells you how much you still owe. Neither tells you the full amount leaving the bank each month; for that, look at the bank or the Statement of Cash Flows, which shows loan repayments under financing.

A worked year: a $60,000 loan for a café

A Melbourne café borrows $60,000 to replace its coffee machine and refit the counter, at 9% a year over 5 years, repaid monthly. The lender’s schedule says each repayment is $1,245.50.

Repayment	Interest	Principal	Loan owed after it
Month 1	$450.00	$795.50	$59,204.50
Month 2	$444.03	$801.47	$58,403.03
…	…	…	…
Month 12	$381.85	$863.65	$50,050.20
Year 1 total	$4,996.20	$9,949.80

The interest in month 1 is a month’s interest on the full balance: $60,000 × 9% ÷ 12 = $450. Each month the balance is a little lower, so the interest falls and more of the same $1,245.50 goes to principal.

Over the year $14,946.00 left the bank in repayments. Only $4,996.20 of it is on the Profit and Loss. The other $9,949.80 shows up as the loan falling from $60,000 to $50,050.20 on the Balance Sheet. If the café’s profit for the year is $48,000, the repayments alone take almost $10,000 of cash that the profit figure never mentions, which is one of the usual reasons for profit but no cash.

The two mistakes that cost the most

1. Coding the whole repayment to an expense. It is the easy option at reconciliation, and it looks right because it is money going out. Here it would put $14,946.00 into expenses instead of $4,996.20, so profit shows $38,050.20 instead of $48,000. The Balance Sheet keeps showing $60,000 owed when the lender says $50,050.20, and if no one catches it, the tax return claims $9,949.80 of principal that is not deductible. Accountants find this at year end and reverse it, usually at your cost.

2. Coding the loan itself as income. The $60,000 arriving in the bank gets reconciled to Sales or Other Income. Profit for that month jumps by $60,000, and so would the tax on it if it were not caught. The loan then never appears as a debt at all.

A quick test for both: run the Balance Sheet at the end of a month and compare the loan line with the lender’s statement for the same date. If Xero shows the original amount, or no loan at all, one of these has happened.

How to record a business loan in Xero

1. Add a loan account. Go to Accounting > Chart of accounts > Add Account. Choose Non-current Liability for a loan over more than a year (a short loan or overdraft-style facility can be a Current Liability), name it after the lender, for example “Loan: Westpac equipment”, and give it a tax rate with no GST or VAT (in Xero Australia usually BAS Excluded, in the UK No VAT, in New Zealand No GST). Your accountant may split it into the part due within 12 months at year end; you do not need to do that monthly.
2. Record the money arriving. When you reconcile the deposit, choose Create (or Receive money) and code it to the loan account, not to income. If the lender paid the supplier directly instead, as equipment finance often does, ask your accountant for the journal: the asset goes up and the loan goes up, and the bank does not move.
3. Record each repayment. When you reconcile it, choose Create and split it into two lines: the principal to the loan account and the interest to Interest Expense, using the amounts on the lender’s statement or schedule. Any fee goes on a third line to bank fees.
4. Or use a rule and one monthly journal. Interest changes every month, so a bank rule with fixed amounts drifts out of date. A simpler routine many bookkeepers use: a bank rule that codes the whole repayment to the loan account, then once a month a manual journal from the lender’s statement that moves the interest (debit Interest Expense, credit the loan account). The loan balance and the interest both end up right.
5. Check it monthly. As part of month end, compare the loan line on the Balance Sheet with the lender’s closing balance. A small difference is usually a fee or an interest amount entered from the schedule rather than the statement.

Hire purchase and car finance work the same way in principle: the interest is an expense and the rest reduces what you owe. In Australia the GST on hire purchase and chattel mortgages has extra rules, so let your accountant set up the first one. Money you lend the company yourself, or take out of it, belongs in a director’s loan account rather than a lender’s loan account (in Australia, a Division 7A loan); for a sole trader or partner, what you take out is drawings.

What the loan means for your monthly numbers

• Profit is not what you can spend. Take the principal off profit before deciding what to pay yourself. The how much can I pay myself guide does this step by step.
• The interest falls, the repayment does not. On an ordinary loan the Interest Expense line shrinks a little every month while the cash leaving stays the same, so the Profit and Loss slowly improves without the bank feeling any different.
• Can trading carry it? Lenders test whether your spare cash covers every repayment, principal included. The debt service coverage ratio calculator shows the ratio, and the net cash flow calculator splits a month’s money in and out so you can see how much the loan takes.
• Before you borrow again, cash flow loans explains how short-term lenders price loans and why weekly repayments free up less cash than the headline amount.

Common questions

Why are my loan repayments not on my Profit and Loss in Xero? Because most of each repayment is principal, which pays back money you were lent rather than a cost of running the business. Principal reduces the loan on the Balance Sheet. Only the interest and any fees are expenses, so only they appear on the Profit and Loss.

Are loan repayments an expense? Only the interest part, plus any fees. The principal is not an expense and is generally not tax-deductible; the interest on a loan used for the business generally is. Check your own case with your accountant.

How do I record a loan received in Xero? Add a liability account for the loan in the chart of accounts (Non-current Liability for a loan over a year), then code the deposit to that account when you reconcile it. Never code a loan to income.

How do I split a loan repayment into principal and interest in Xero? When you reconcile the repayment, create a spend money transaction with two lines: the principal to the loan account and the interest to Interest Expense, using the lender’s statement. Or code the whole payment to the loan account with a bank rule and post the month’s interest with a journal from the statement.

Why doesn’t my loan balance in Xero match the lender’s statement? Usually because repayments were coded entirely to the loan (so interest was never added back) or entirely to an expense (so the loan never fell), or a fee was missed. Compare the two month by month from the start of the loan to find where they part.

Where do I see how much of my cash goes on loan repayments? In the Statement of Cash Flows, under financing activities, or by running Account Transactions for the loan account. The Profit and Loss only shows the interest.

Does a loan affect my profit? Only through the interest and fees. Borrowing money does not increase profit, and repaying it does not reduce profit, even though both change the bank balance.

See the cash, not just the profit, every Monday

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