Business owner drawings: how taking money out of your business can affect your finances
For many business owners, one of the advantages of running a business is having greater control over how money is used.
However, taking money from the business for personal purposes needs to be handled carefully.
Depending on your business structure, money taken by an owner may be treated differently for accounting and tax purposes.
This is why business owners should understand the difference between business expenses, wages, drawings and other payments to owners.
What are business drawings?
The term "drawings" is commonly used when an owner takes money from a business for personal use.
For example, a sole trader may transfer $3,000 from the business bank account to their personal account.
That transfer is not necessarily a business expense.
It is money being taken by the owner.
How the transaction is treated depends on the structure of the business and the circumstances involved.
Why mixing personal and business money causes problems
One of the simplest ways to make financial administration more difficult is to mix personal and business transactions.
For example, using the business bank account to pay for:
Groceries
Personal holidays
Household bills
Personal entertainment
Private purchases
creates additional work when reconciling the accounts.
It can also make it harder to understand the true financial performance of the business.
Business expenses are different
A genuine business expense is incurred in running the business.
Examples could include:
Office rent
Business software
Advertising
Professional services
Business insurance
Work-related travel
Business equipment
Personal spending should not simply be recorded as a business expense because the payment came from the business bank account.
Correct classification matters.
Why business structure matters
How money is taken from a business can depend heavily on whether the business is operated as:
A sole trader
A partnership
A company
Another business structure
Company owners, for example, may have shareholder current accounts and other considerations that do not apply in exactly the same way to sole traders.
This is one reason business owners should obtain professional advice rather than relying on assumptions.
Don't confuse drawings with profit
Another common misunderstanding is assuming that taking money from the business means the business has made that amount of profit.
It doesn't.
Imagine your business generates $200,000 of revenue and has $150,000 of legitimate business expenses.
The resulting profit is not determined by how much money you transfer to your personal account.
Similarly, taking $50,000 from the business does not automatically mean the business made $50,000 of profit.
Profit and owner withdrawals are different concepts.
Set a sensible personal income strategy
Business owners need to think carefully about how they fund their personal lifestyle.
If you continually take money from the business without considering upcoming obligations, you could create cash flow pressure.
Before taking significant amounts out of the business, consider:
Upcoming tax obligations
GST commitments
Supplier payments
Payroll
Loan repayments
Planned investments
Working capital requirements
Future cash flow
A healthy bank balance today does not necessarily mean the money is available to spend.
Keep records of money moving between you and the business
Every transfer between personal and business accounts should be appropriately recorded.
Good records help your accountant understand:
What the payment was for
Whether it was personal or business-related
How it should be treated
Whether further action is required
Clear records also make financial reporting much easier.
Don't wait until year-end to discover a problem
Owner transactions should be reviewed regularly.
If large amounts have been taken from the business throughout the year, it is better to understand their financial and tax implications sooner rather than later.
This gives you more options to address issues before they become significant.
Get advice before making major withdrawals
Business owners often focus on how much money they can take out of the business.
A better question is:
How much can I take while keeping the business financially healthy and meeting its obligations?
That requires looking at the bigger financial picture.
At Affinity Accounting & Advisory Limited, we help New Zealand business owners understand their financial position, manage their accounting requirements and make informed decisions about their businesses.
If you're unsure how owner drawings or payments should be handled, speak with your accountant before making significant withdrawals.
What our clients say
“Dylan is one of the best accountants I've worked with. He makes a point of explaining things as plainly as possible to those of us who don't understand accounting speak. He has a solid knowledge of best practices in the industry, but most importantly he will always recommend what is most suitable for your specific business. I will continue to recommend Dylan and Affinity Accounting to my clients when they are looking for an accountant.”
-Jay Brooker