We are going to look at one example where the owner has decided to have an owner's draw of $10,000.
- Make sure you have a Drawing Account. If not, create one. This should be of type Equity and have Equity as the Parent Account.
- On the last date of the month, write a check from the business account to your personal account and create an entry in the Drawing Account, as shown in the following screenshot, with the Transfer account being the Checking Account and the amount being $10,000.
One prudent approach to paying the owner is a monthly fixed sum as owner's draw to cover the owner's personal expenses. At the end of the year, depending on how well the business has done and the cash position, the owner can draw an annual bonus. This also helps you to visualize the benefits of running your business. How? If you make a monthly withdrawal that is roughly equivalent to what you can earn as a salaried employee, then you can readily see what is the extra benefit that you get by way of an annual bonus by putting in all those 80 hour weeks, running your own business.
If you don't follow the system outlined by us above, there are a few ways in which draws can happen:
- You write a check to "cash" with no memo
- You use your business debit card for personal use
- You use your business ATM card to withdraw funds from the bank for personal use
- You initiate bank cash transfers from your business to your personal account.
- You write a check from your business to pay a personal expense.
If you draw cash through any of these means, make sure you enter them in the accounts with a matching increase in the Drawing account.
Talking about a prudent approach, you will owe at least two large chunks of taxes from the owner's draw. There may be others. You need to set aside 15.3% self employment tax every time you draw some amount from the business. This self employment tax is nothing but the 7.65% FICA tax that we saw earlier in the payroll section. Except that now you are paying the employee contribution as well as the company contribution and so it has got doubled. You will also owe estimated income tax that is payable each quarter. So, you will do well to keep these amounts aside before planning to spend the money.
- What type of account is a Drawing account?
a. Expense account
b. Income account
c. Liability account
d. Asset account
e. Equity account
Let us say that you have a partnership account with two partners. Set up two Drawing accounts to show the withdrawal of the two partners separately. Please follow the same method as we outlined for creating a drawing account for a sole owner, except create two of those. Also, use each of the partner's names in the account name to clearly identify them. This way each partner's drawing can be tracked separately.