Owners can take money out of their company legally as a “draw” or “distribution.” There is no payroll tax withheld, but you will pay tax on an estimated quarterly basis. The amount of distribution you took this year to date, shows here in the equity section as a negative number, because it reduces the equity in your company.
So, for example, let’s say your Retained Earnings from being in business for five years is $400,000, and your current year-to-date earnings are $100,000. You see that you have plenty of cash and your current liabilities are low. So, you want to take a “draw” or a “distribution.” If you take $40,000 in one lump sum, it will show here on your Balance Sheet. The distribution will offset your Current Year Earnings, and reduce the equity in your company.
On January 1, your current year earnings and distributions get rolled into retained earnings and those two accounts go back to zero.
Retained earnings only change once per year – on January 1, and this number stays the same for 12 months. It represents performance from inception to the last day of the previous year.
So, let’s recap this equity section of the Balance Sheet. Common stock is that first check you ever wrote to open the business’s checking account. Equity Investments is any more money you put in after that to keep your business going. Retained earnings are how much profit is left in your company from previous years. Current Year earnings is how much profit or loss you have from Jan 1 of the year you are in, to date. Distribution to Shareholder is how much money (besides weekly paychecks) you took out of the business this year. It shows as a negative number.
On January 1 of each year, Current Year earnings and Distributions are rolled into Retained Earnings and they go back to zero.
So, let’s say it’s December 31. On your Balance Sheet under Retained Earnings, it says $500,000. It has said that every month this year – because the Retained Earnings number only changes once a year – on January 1.
Your Income Statement says your company made $400,000 this year. That exact same number appears on your Balance Sheet under “Current Year Earnings.” Under Distribution to Shareholder, it says you took $300,000 out of the company this year.
So tomorrow, January 1, you add Retained Earnings of $500,000 to Current Year Earnings of $400,000 and subtract Distribution to Shareholder ($300,000) and you get a new Retained Earnings figure to carry for the next year of $600,000. The Current Year Earnings and Distribution to Shareholder accounts go to zero and will change each month based on what activity goes on.
Get it?
I need to read that a few more times. Someday I will have money to distribute once I get out of debt. Thank you for these Think Daily Comments, they are helping me.
Don
Larry,
Lots of good information, is this the same for all forms of business (we are a sub chapter S corp)? We are taxed at the end of the year on all our cash and accounts receivables and go through a juggling act of paying out nearly all cash (sometimes with a loan from our line-of-credit), paying tax on that distribution and turning around and putting most of the remaining cash back into the business (in order to meet our day-to-day cash flow). The good news is, after 33 years of business our retained earnings has grown, our business is debt-free and our profitability is excellent.
Unfortunatelly I saw many cases where the numbers in the accounts were not representing accurate digits because there were too many people handeling them and the entries were incorrect and the corrective actions were done incorectly creating a big mess. Your given example nicely summerizes the double entry concept.
Similar comment from what Dayton wrote: I think this discussion is specifically about C-corp balance sheets. It would be different for S-corps, LLCs, or proprietorships (who all should have balance sheets as well).