SMALL BUSINESS BLOG
Are you a sole trader? Let’s talk about owner drawings…
A question that lands in my inbox quite frequently is “how & when do I pay myself?"
Unfortunately, there isn’t a standard answer that I can quickly send as it all depends on your personal and business situation, your expectations and your growth plans, but let’s talk about it in a broad sense for a few minutes.
As a sole trader, YOU are YOUR business and the tax man treats you as one in the same, which means you cannot pay yourself a wage from your business, but you can draw down on business funds for personal use – this is known as taking Owner Drawings (think of it as a distribution of profits) and you can do this any time you like - the only limitation is the amount of funds in your bank account that you can withdraw.
Owner drawings don’t affect your profit or loss position in any way as they come from the equity of the business. Owner’s equity represents the net worth of a business that belongs to the owner and is the total value of the business net assets after all liabilities have been deducted. More specifically, we can view equity as an accumulation of any funds you have put into the business since it started & any profit (or losses) generated over time.
Let’s look at an example!
Imagine you’re reviewing your balance sheet and your equity section looks a little like this;
If there is equity available in the business and funds in the bank (this is important for cash flow) then you have capacity to take owner drawings. Based on initial funds put in by the business owner plus profit made in the business over time, there is a balance of $25k in the equity account which the business owner can 'draw down' on either in lump sums as needed or as a substitute for a regular weekly/monthly wage.
The important thing to ask yourself before doing this is whether doing so would prevent the business from having enough capital to continue operating as needed. If you know you have some large expenses coming up, or that you’re about to head into a quiet sales period (but you still have overheads to cover) then those funds might be better off remaining in the business as a buffer.
It’s worth noting that it is possible to go into negative equity (eg you have more liabilities than assets or you draw extra owner funds) and this can be a fairly common occurrence for new businesses (especially ones with a lot of start-up costs) but it can also be a sign of trouble ahead!
I think we can all agree that nobody goes into business for themselves to work for free – sure there are a multitude of other benefits to being your own boss, such as flexible time, choice of where/how you work etc – but at some point you need to start getting a financial benefit or you’ll just have an expensive hobby!
A great practice to get into from day 1 of your business (though it’s never too late to start) is to have a clear vision between what belongs to the business vs what is ‘your money’ – creating a budget for your business is an excellent exercise to help you map out your income and expenses for an estimate of when you will likely become profitable and by how much – and as soon as you start making a profit from your business you should start paying yourself.
By taking a regular weekly 'drawings' amount and putting it into your personal bank account you are setting yourself up with a really healthy money habit that not only rewards you for your hard work but will motivate you to build your revenue. It’s also an excellent bookkeeping practice because separating your business and personal expenses will help you maintain a very clear picture of how your business is performing!