Wanting to know what is a drawings account?
Your net income should exceed your gross habits!.. or why keep your cash flow separate from the business
When asked the key to financial happiness one business owner said – ‘Your net income should exceed your gross habits!’
Jokes aside, I urge business owners to keep their own finances separate from those of the business, in order to manage both sustainably and for the survival of the business.
Separating your personal finances from those of the business can have a very positive impact on the cash position of both parties.
Some SME/SMB owners run their business bank account as if it was an ‘open tin’ for themselves and their families. If carefully managed and monitored this may not be a problem.
The problem is, we have rarely seen a situation where it is monitored at all, and therefore is mostly a problem!
If the situation isn’t managed well it’s difficult to know how much of the funds are available and required by the business as well as the business owner. If the business bank balance suddenly goes up it can be very tempting to pay yourself a bonus because you think you deserve it.
The real question is – can you afford it? Some will get carried away the minute a big sale is made and using the income to fund personal luxuries. Later they regret spending the business’ working capital when finances get tight.
This is usually the point at which they need to head to the bank for an overdraft and find they have to encumber the family home to secure funding. In effect the overdraft is required to support their personal spending habits.
Drawings accounts are often used as a way for business owners to funnel personal spending through the business, then tally it up at the end of an accounting period and pay the relevant tax.
Again this is fine if you have some kind of control on the situation. A problem occurs when there is no limit on spending or income drops. This situation is often made worse when family members have credit cards on the business account.
I have personally seen some horrendous credit card bills from family of business owners, that the business just cannot sustain. Would a business owner allow their employees to take a wage/salary that reflected their spending ability rather than their earning capacity – I think not. Taking a wage/salary over drawings means personal spending must be disciplined. Employees have to do it, so why not business owners?
Another drawback with running Drawings accounts is that you effectively have to enter every item of personal spending in your accounting system, which can be quite time consuming and not very beneficial.
The best way to manage a business is to treat it as a separate entity from yourself as the business owner. The business must be able to survive on it’s own merits. If a business owner is constantly dipping into the business’ funds uncontrollably, it doesn’t stand a chance of surviving.
The finances of each entity need to be managed separately. This begins in both circumstances with a budget. The business needs a budget so that it knows if it will make a profit and be able to meet cash obligations. The business owner needs a budget so that they know if they can meet their own living costs and obligations.
I have been in business for twenty plus years and from the very start I paid myself a wage and never pay personal expenses from the business. I am happy I took this decision, as it has made things so simple. I never have to worry about a big tax bill at the end of the year, because it’s been paid throughout the year.
I never have to wonder how much of the money in the business bank account belongs to the business and how much belongs to me.
Another benefit of paying yourself a salary is that you will become disciplined to pay pension contributions in just the same way that you pay them for staff – on a regular basis.