Hello! Welcome to Money Matters with me, Kash the bookkeeper! Accounting is the language of business. If you own a business or you are thinking of starting a business, you need to know your numbers and how to use them!
Money matters is all about the fundamental basics of the accounting language, Assets, Liabilities, Owner’s Equity, Revenue and Expenses. These building blocks of business can be arranged and rearranged for a customized experience. Once you understand the basics of any language it is much easier to communicate using that language.
We have discussed gaining assets, leveraging liabilities, avoiding and getting out of the debt trap, with bookkeeping breadcrumbs scattered throughout. Need to catch up? Click here for all of the prior shows: https://feed.pod.co/money-matters-with-kash-the-bookkeeper
Today’s focus is all about YOU! Yes, you, the business OWNER and your worth in your company.
Show Objectives - The Why
Owners’ equity rounds out one of the basic equations of accounting:
Assets = Liabilities + Owners Equity.
We can rearrange this equation to say:
Assets- Liabilities = Owners Equity.
The accounting definition of owners’ equity is the “owners’ claim to company assets after all of the liabilities have been paid off.” Which is why it is often referred to as “Net Assets.” The term owner’s equity is used as a generically, and is most commonly used for sole proprietorships. Partnerships typically call their equity accounts “members’ equity” and C and S-corporations use “shareholders’ equity.” But that’s not all folks! There’s more!
Inside of the broad owners’ equity category there are several different subcategories we need to consider.
Contributions or “owner investments” is when an owner puts money or other assets into the company. Often this happens at the onset of starting a business, but there can be several injections of capital made throughout a business life cycle. The important thing here to remember is to NOT classify injections of capital as “Revenue”, these transactions should increase the equity accounts.
Withdrawals or “owner distributions” happen when an owner takes money or other assets out of the company. This obviously reduces the owner’s capital account and the overall owner’s equity. A common error here is classifying these withdrawals as a payroll expense of the company.
As the business earns income or incurs losses, the net income or loss is added to the capital accounts as the final piece in the Balance Sheet puzzle.
To sum up (see what I did there), owner’s equity = contributions – withdrawals + net income + ( in year two and beyond ) retained earnings! The full equation now looks like:
Assets-Liabilities = Owner’s contributions- Withdrawals + Net Income (and retained earnings)
Key Issues - Owner Perspective:
Let's be transparent for a moment, if you own a business you started this business in order to support a lifestyle. At some point you are going to want a return on your investment from your business. You may have heard of business owners taking a salary from their business but that's not actually how most business owners get paid. Let me be very clear you are not an employee of your business unless you are an employee of your business. So, if you are not on payroll and you do not fill out the appropriate tax forms and you are the owner of the business then you are not an employee. How you pay yourself out of the business depends on the structure of your business, the stage of business that you are in and most importantly how much you need to maintain your personal lifestyle.
One of the top five questions I receive from my clients is how/ how much do I pay? The answers can be found in your owners’ equity section of your balance sheet. Consider the following questions and if your books and records accurately reflect the reality of the situation.
What You Need to Know - The What
Check out this handy guide to find out how you can pay yourself!
It's clear to see how impactful the structure of your business is on how your business is taxed. Depending on the type of distribution you can receive there are various taxes that you are responsible for, and not for.
What You Need to Do - The How
Business Owner Draw vs. Distribution
Notice the terms "draw" and "distributive share" in the table above. A draw is a direct payment to a sole proprietor from the business, often via check, cash withdrawal, or payment of personal bills. A distributive share is an individual owner's share of net income, profit or loss. It includes all contributions, withdrawals and credits.
How Much to Take From Your Business
The National Federal of Independent Business says:
If you’re just starting out, the biggest determining factor for your pay is going to be your business’ cash flow. Wages, expenses, and all immediate obligations must be covered with cash. With limited or no cash flow—a reality for many startups—you might operate for a while without a paycheck, let alone a predictable salary.
Later in your business life, you may be able to take money from your business on a more regular basis, based on your personal financial situation.
Previous: Liabilities, taming the debt monster
Next: The accounting balancing act aka The Balance Sheet
Written by Kash the bookkeeper
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