Small business owners often use their personal assets as an investment in their companies with the expectation that they can later withdraw funds as needed. Others want to take advantage of their company’s growing bank account to compensate themselves for their contributions. In either case, they can do so with owner draws or drawings, which take money out of the company’s capital account and transfer it to the owner. This type of withdrawal, which companies typically issue from a business chequing account, and the owner deposits in a personal account, are also helpful for keeping personal and business expenditures cleanly separated.
The owner does not have to pay additional income taxes on this draw, as the business applies the taxes at the company level and then allocates a portion of those taxes for the owner to claim on their individual personal income tax filings. Similarly, these draws do not affect the net income of the company, as they are a reduction of the company’s capital and not an expense for tax accounting purposes.
Owner draws are only available to owners of sole proprietorships and partnerships. In a corporation, owners can receive compensation by a salary or dividends from ownership shares but not owner draws. Typically, you account for owner draws with a temporary account that offsets the company’s owner equity or owner capital account. At the end of the fiscal period, you close this account by reducing the company’s equity or capital account by the amount in the temporary account. By doing so, you keep a clean record of the transfer of company assets to the owner. This allows owners to make use of their company’s financial holdings while keeping accounting records in order for both the business and personal year-end filings.
If you do the bookkeeping for a company, it’s important to understand how owner draws work so you can account for them in the books. If you are a professional accountant, you should help your clients understand issues such as owner draws. That knowledge helps them to run their business finances more effectively.
