Breaking down the four types of owner withdrawals and how they affect the company’s financials.
E. Miller · Follow
4 min read · Oct 15, 2019
There are countless situations in which business owners get money directly from their company. All owner payments can be placed into one of the following categories:
- owner withdrawals
- profit distributions
- guaranteed payments
- expense reimbursem*nts
The first two categories (owner withdrawals and profit distributions) affect the amount of owner’s equity on the balance sheet, while other two (guaranteed payments and expense reimbursem*nts) affect the amount of net profit/(loss) on the income statement.
Why does any of this matter? If owner transactions aren’t accounted for properly, it affects more than the owner — it affects the whole company. From the accuracy of its financial statements to how much the company owes in income tax, the importance of accounting for owner transactions can’t be stressed enough.
Profit Distributions
Rather than reinvesting earnings back into the company, business owners have the option to collect their share of profits at the end of every period. This is known as a profit distribution, and each one an owner takes reduces their owners equity.
An LLC’s operating agreement should outline how profits will be split between owners. Profit distributions can be a monthly, quarterly or yearly occurrence, depending on what is specified in the operating agreement.
In an LLC with two equal owners, a $100,000 profit would be split 50–50, so both owners would receive $50,000. To record this distribution on the company’s books, the cash balance is reduced by $100,000 and both owner’s equity accounts are reduced by $50,000.
Since only balance sheet accounts are involved, profit distributions to owners do not affect net income.
Owner Reimbursem*nts
In situations where an owner uses personal funds to pay for a business expense, the company needs to record two separate transactions: the expense paid on the company’s behalf, and the amount to be reimbursed to the owner.
Let’s say the owner paid the company’s insurance premium. The journal entry would debit the insurance expense account, and credit a liability for the amount owed to the owner. With a $1,000 insurance premium, the first journal entry would be:
After the owner is reimbursed, the second entry removes the amount due to the owner, and reduces the company’s cash balance by the same amount:
Guaranteed Payments
In situations where an owner contributes their time and resources to the daily operations of the business, the operating agreement normally specifies the amount they will receive as a guaranteed payment, and how often. Similar to an employee salary, guaranteed payments are a normal operating expense.
One distinguishing characteristic of guaranteed payments is that they’re always the same amount (once again…specified in the operating agreement), regardless of how profitable the company was during the period.
For a $1,000 weekly guaranteed payment, the journal entry would increase salary/guaranteed payment expense, and decrease cash. Since a sub-account of salaries and wages expense is involved, guaranteed payments to owners will affect net income.
Owner Withdrawals
In situations where an owner withdraws money from the business for their personal use, the amount is charged against their owner’s equity account. This effectively reduces their ownership percentage in the company, which is an important distinction.
An owner withdrawal is a voluntary action by that individual— so it can NOT be considered a business expense. Charging a withdrawal against the owner’s equity account helps make sure all owners get their rightful share of profits. One person shouldn’t be allowed to withdraw thousands of dollars from the business and still get the same amount in profits as a co-owner who hasn’t withdrawn a penny.
To record an owner withdrawal, the journal entry should debit the owner’s equity account and credit cash. Since only balance sheet accounts are involved (cash and owner’s equity), owner withdrawals do not affect net income.
Key Takeaways
All companies should have a process in place to make sure owner transactions are recorded correctly, otherwise they run the risk of seriously distorting their financials.
This is especially important in companies with multiple owners. If questions or issues arise in the future related to one owner’s rightful share of profits, strong record retention policies provide an easy way for companies to go back and ensure that all transactions involving a particular owner were properly accounted for.
