The terms "drawing" and "withdrawal" in a business can be somewhat confusing since they sound about the same. A "drawing" refers to an owner’s removal of cash from the business earnings. It is method used by sole proprietorship owners to pay themselves. The term “accounting drawing” is synonymous with "owner's draw," or "owner’s withdrawal." The term "withdrawal" is loosely used to represent an amount of funds removed from the business for an expenditure or in some cases to represent the withdrawal of funds from a company retirement account. An owner's drawing affects the capital account of a balance sheet, whereas a withdrawal has no such effect.
How to Take an Accounting Draw
When your business is a sole proprietorship, you don’t pay yourself wages. You pay yourself by taking the available profit in the business in the form of an owner's draw. You simply write yourself a check from the business checking account without making tax withholdings. For example, if the profit during the month is $6,000, you can write yourself a check in the amount of $6,000. On a sole proprietorship books, the entry would be as follows: credit (reduce) cash on the balance sheet by $6,000 and debit (increase) owner’s draws on the balance sheet by $6,000. By making a draw entry on the balance sheet, you can keep track of how much profit you have actually taken from the business.
How to Take a Business Withdrawal
A business withdrawal in accounting terms is the removal of cash, but not to reimburse the owner as in an owner's draw. A withdrawal can be made for a variety of reasons, including reimbursing an employee for a business expense or to pay for a business expense that might require cash such as entertaining a key customer at a sporting event. A withdrawal also can signify the removal of funds from a company retirement account such as a 401k. Also, some companies have a petty-cash fund set up for miscellaneous, small expenses and a withdrawal might also be made from this account for certain incidental expenses.
Tax Implications of an Owners Draw
An accounting drawing -- or owner's draw -- is not taxable as such. A sole proprietorship is only taxed based on the profit and loss of a business irrespective of an owner's draws. An owner’s draw has no effect on profit since it is not an expense. For example, if a sole proprietorship shows annual gross sales of $100,000 and $65,000 in expenses, the tax on the business would be based on $35,000, even if the owner took $45,000 in draws. In this case, the owner's draw in excess of the actual profit would simply reduce the owner’s capital account on the balance sheet.
Owners should be careful to not draw more than the available capital in a business. This could leave the business with cash-flow problems when trying to meet ordinary operating expenses. Also withdrawals from the business should usually be assigned some form of accounting code to denote a particular cash expense. For example if a $200 withdrawal is taken, it should reference some expense category such as travel and entertainment expense on the profit and loss statement.