Business owners extract value from their companies in a number of ways. The company may pay for the owner's insurance, vehicles, retirement and other perks. It may be used to access additional tax deductions in addition to providing a salary and benefits. However, the primary way owners derive value from profitable companies is through owner distribution of profits. These distributions are not shown on the profit and loss statement. Instead, they appear on the balance sheet.
Owner distributions are your withdrawals from the business for your personal use. Owner distributions include any withdrawal that is not tied to a business expense and is paid as a distribution or dividend to a company owner. Owner's distributions are officially made from retained earnings, which is the summation of net income from prior periods, although your company actually pays you from its cash.
The profit and loss statement, also called the income or net income statement, reflects your business's operational performance over a specific period, typically quarterly or annually. It provides a record of your business' sales and expenses and reflects profits at several stages, including gross, operating and net. What it does not show is how your company distributed profits to its owners and investors.
The balance sheet reflects your business's assets, liabilities and equity, or what your company owns, owes or is worth, at a specific moment. Specifically, on a balance sheet, assets equal liabilities plus owner's equity. Your owner's equity records what you and any co-owners initially contributed and any additional contributions, typically referred to as additional paid-in capital. Owner's equity also reflects retained earnings less any distributions or withdrawals by the owners.
At the end of each calendar or fiscal year, you increase or decrease your owner's equity account by the amount of net income or net loss from that year.
For example, your owner's equity account on your balance sheet shows $50,000 in initial contributions, $50,000 in additional paid-in capital and $200,000 in retained earnings on Dec. 31 of the previous year for a total of $300,000 in owner's equity. For the same year, your company generated a $200,000 net profit, shown on the profit and loss statement.
On Jan. 1 of the following year, your balance sheet shows retained earnings of $400,000 -- which is the $200,000 prior amount plus the $200,000 in net income from the just-ended year. Your income statement shows $0 sales and profit, because the new period has just begun.
If you took distributions on Dec. 31, you would reduce the $400,000 by the amount you withdrew as an owner. It is this transferring of net profit or net income to the balance sheet to become retained earnings that can cause some owners to mistakenly think owner distributions are shown on an income statement.