What Is an Owner's Draw and How Does It Work?
Taking a Draw From Your Business
An owner's draw, usually just called a "draw", is an amount taken out of money taken out from a sole proprietorship or partnership by the owner for his personal use. It's called a draw because money is drawn out from the business.
Three types of business owners typically take draws.
What Business Owners Take Draws?
Owners of small businesses typically don't take a salary because they aren't employees. The types of business owners who take draws instead are sole proprietors, partners in partnerships, and owners or members of limited liability companies.
A self-employed business owner makes an initial investment called a capital contribution to the business from her personal funds. Then, during the course of the business, she takes money out as draws and invests more money from profits or from personal savings.
Business owners generally take draws by writing a check to themselves from their business bank accounts. For accounting purposes, the draw is taken as a negative from their business ownership account, called owner's equity.
In some cases, self-employed business owners might have an option to take either a draw or a salary depending on the tax circumstances. Check with your tax professional before taking a salary from your business if you're self-employed.
Why Don't Corporate Owners Take Draws?
Owners of corporations are shareholders and they take money out of the corporation as dividends. If an owner of a corporation works for the company, she is considered an employee and is additionally paid a salary for her work.
How Does a Draw Affect a Business Owner?
Owners' draws decrease their capital accounts. This is the account on the business balance sheet that shows how much the owner has invested in the business less amounts taken out in draws at any point in time.
Be sure to keep business and personal spending separate if you have a small business. The owner's draw should be the only place where personal and business funds intersect.
Taking a draw does not affect the owner's taxes because it's not taxable income. One disadvantage to taking a draw is that you don't have a personal income to show for personal loans or home mortgage purposes because it isn't reflected on your business tax return.
How Many Draws Can a Business Owner Take?
An owner can take as many draws as he likes at any time. Of course, there must be money in the business checking account that's available to be withdrawn. Some business owners take monthly draws like a salary.
During the startup of a business, it's common for the owner not to take a draw until the business has a positive cash flow. Just because your business is profitable on paper, this doesn't mean you have enough cash in the bank. You might not be able to take a draw at all because all your available cash is needed to pay off bills until your business income exceeds your expenses.
Consider both short-term and long-term needs for the money coming into your business before you take a draw. If you take a draw in one month and you don't have enough cash to pay a tax bill or make your lease payment the next month, you can get into financial trouble quickly.
How Do Draws Affect Business Profits?
How much a business owner takes out of the business has no affect on the profit of the business. Owner draws are not an expense of the business and amounts drawn are not tax deductible to the business. Owner draws are not taxable as personal income to the business owner.