The Effect of Cash Distribution on a Balance Sheet

Owners create companies to generate revenues and earn profits that accrue benefits to them either in the form of increased company value or through profit distributions. Most small businesses are not sold as continuing enterprises and do not go public. Therefore, most small businesses deliver value through cash distributions of their profits to their owners. Distributions affect both the assets section and the owner's equity section of the balance sheet.

Cash distributions are owner withdrawals. As a company's owner, whether as shareholder, partner or sole proprietor, you are entitled to withdraw funds out of your company's retained earnings for personal use. If your company has more than one owner, then you must all agree on the amount and the timing of distributions. Putting a written policy in place can reduce the potential for disputes. Your company pays the cash distributions out of its available cash. Cash distributions to C corporation shareholders are generally called dividends.

The balance sheet provides a snapshot of your company's holdings and obligations at a specific point in time, typically the end of an accounting period. The accounting equation that governs the balance sheet is assets equal liabilities plus owners equity. This equation means that what the company owns must equal what the company owes to external parties and to the owners. Assets are valuable items that can be sold or used to generate revenues, and liabilities are debts or obligations the company must fulfill.

Owners equity is the company's net worth or book value. It includes amounts you and co-owners initially invested, any additional paid-in capital to strengthen the balance sheet or fund expansion, and retained earnings or profits. Cash distributions reduce the company's net worth and are typically subtracted from retained earnings. Retained earnings are the cumulative net income from prior periods. Profits your company retains become part of owners equity on the balance sheet.

When you take a cash distribution as an owner, you reduce the amount of retained earnings in the owners equity section of the balance sheet. You subtract the amount of the distribution from this line item, because the company is no longer retaining that amount. Instead, the company is distributing it to you and any co-owners or investors. Since the balance sheet must balance, the cash distribution also reduces the cash and cash equivalents line item in the asset section by the same amount.