If you're doing business as a sole proprietorship or partnership, there will more than likely come a time when you and/or your business partner will want to withdraw funds from your business for personal use. How can you do this through your small business accounting in a way that keeps your personal and business finances separate and organized? A good way is through the use of a drawing account (aka "owner's draw").
What is a drawing account? It's a contra account to the owners' equity account. Think of it like the opposite or offsetting account to the owners' equity account. It's used to draw funds from the business (hence the name "drawing account") so you can use them to cover personal expenses when needed.
The Accounting Equation
Owners' equity is part of the accounting equation. You may already be familiar with this equation, but just in case, here's a quick refresher:
Assets = Liabilities + Owners' Equity
We already know that the drawing account is the contra equity account for the owners' equity account, so let's take a look at what happens to owners' equity and the rest of the accounting equation when funds are drawn from the drawing account. Say you want to withdraw $1,000 from your business to pay for a personal expense, such as bills or a loan payment. This money is deducted from the cash account, which is part of your assets, meaning the left side of the accounting equation will decrease by $1,000. The equation stays in balance, because this withdrawal also decreases the owners' equity account by the same amount.
Note that withdrawals from the drawing account are not the same as an expense. To learn more about expenses, check out our recent blog post, What is an Expense in Accounting?
A Temporary Account
A drawing account is not a permanent account. Instead, it's intended to be used over the course of a single year to track the funds distributed to partners/owners of the business during that same year. So what happens to the drawing account at the end of the financial year? The account is closed out by applying a credit, and the balance is then transferred to the owners' equity account by means of a debit. (Confusing? Now might be a good time to head over to our blog post, What is a Debit and Credit in Accounting? for a great overview of debits and credits.)
Even though it's a temporary account, it's worthwhile to pay close attention to your drawing account and keep detailed summaries of any withdrawals that are made. By doing so, you can avoid any potential disputes or confusion between business partners when it comes time to distribute each partner's share of the company's earnings.
Want to learn the ins and outs of setting up a drawing account in Kashoo? We have an entire support page that teaches you step-by-step how to set up and use a drawing account, whether your business is a sole proprietorship, partnership, or even a corporation.
Have related (or even unrelated!) questions? We'd love to hear them. Reach out to us anytime at firstname.lastname@example.org.