What is Owner's Draw in QuickBooks? How Does Owner's Draw Work?
If you are a sole-proprietor, you may have wondered about the Owner’s Draw account and how it works. I’ll try to explain it in a way that makes sense to people who use QuickBooks.
Owner’s Equity, Owner’s Investment, and Owner’s Draw - Defined
If you open the Chart of Accounts in QuickBooks, scroll down to the Equity accounts – normally about half way down. You may see one or more of these names: Owner’s Equity, Owner’s Investment, or Owner’s Draw. To make it easier to understand, we’ll say, for now, that the above terms are synonymous. Some accountants reading this may not agree, but I think for anybody who doesn’t understand what they mean, it’s easier to understand them if we use the terms interchangeably.
Here’s what I want you to know about the above terms: they all represent the amount of personal money the owner has put into, and taken out of, the business. Notice the emphasis on the word personal - this means money generated outside of the business' activities.
Whatever the name, if it has a positive balance, this represents the sum total of personal money you’ve put into the business. If it has a negative balance, this represents the sum total of personal money you have removed from the business.
How much money can I draw out of the business for personal expenses? Is there a limit? Do I pay taxes on that money?
Sole proprietors may draw out as much personal money from the business as they wish, with no tax implications. Taxes are paid based on the profit of the business, not on the money the owner removes from the businesses for personal purposes.
Also, it does not matter how much money the owner originally invested. In fact, it’s extremely common for the owner to draw out much, much, more from the business than he/she originally invested. This is not illegal, and is, in fact, the way the owner pays him/herself for operating the business.
What if I didn’t keep track of personal money I put into the business?
It's not really a problem, in and of itself. It becomes a problem when personal money was used for business expenses. If the money cannot be tracked, it means that there is no receipt or statement showing where the money came from or, more importantly, what it was used for. This means, in turn, that the expense cannot be claimed on a tax return.
The idea here is that you always need to be able to justify business expenses. In an IRS audit it won’t matter how the expense was paid for in a sole-proprietorship – what matters is the documentation (receipt, invoice, statement, etc.) showing that it was an actual business expense.
How do I record Owner’s Draw in QuickBooks?
Any time you use business funds for personal reasons, you will assign the Owner’s Draw account in the lower half of the screen. This is true for the Write Checks and Enter Credit Card Charges screens. You probably won't ever use the Owner's Draw account from the Enter Bills screen - if you ever find yourself doing this, call your accountant before finishing the transaction.
Here's how to record it: from the Write Checks or Enter Credit Card Charges screens, record the date, amount, and other information as needed in the upper half of the screen. Then, in the lower half (the Expenses Tab), open the account box and scroll up to select the Owner’s Draw account. This ensures that personal expenses are not deducted from business income.
I want to show the personal money I put into the business as a loan to the business – is this ok?
Sure, it’s ok. You can do that if it makes you feel better. But remember: a sole proprietor is the businesses. It’s like loaning money to yourself. That doesn’t really make sense, but if it helps you, then do it. I’m not crazy about recommending this option, but since sole-proprietors don’t submit their balance sheets to the IRS (unlike other entities), I think it’s ok, especially for the first year or two.
I normally recommend that people show personal money invested in the business as an increase to Equity, and personal money withdrawn from the business as a decrease to Equity. People don’t loan money to themselves, but when personal money is added, it adds to the Equity, and when personal money is withdrawn, Equity is reduced. From an accounting standpoint it is more accurate to record it as additions and subtractions to Equity. But whichever way you will use consistently and accurately is really the most important thing!
I hope this answers your questions about Owner’s Equity accounts in QuickBooks. If you have more questions, feel free to submit them to me.
About the Author: Jennifer A. Thieme is a Certified QuickBooks ProAdvisor who loves to write about QuickBooks issues. She brings unique insight, clear instructions, and over ten years of experience to all of her QuickBooks articles. Owner of Solid Rock Accounting Services, Jennifer's clients enjoy these same benefits on a personal and regular basis. You can too - visit http://www.jenniferthieme.com and contact Jennifer today.