As we worked through the numbers,it turned out that wasn't quite the case. The business wasn't actually losing money but it was pretty close to it. It was operating around break-even and the problem was that the owner had been drawing more than $150,000 from the business each year.
There was nothing wrong with taking drawings instead of PAYE (have that conversation with your accountant), but the business does need to be making a profit at some stage. To compound matters income was quite often received in advance, so cash & profitability wasn't clear at a glance.
The issue was that nobody had stopped to separate three very different things.
Many owner-led businesses slowly blur the lines between these three points. A little extra cash comes out here, a personal expense gets paid and is coded to drawings and the business funds something because it's easier than paying for it 'personally'.
None of these decisions seem significant on their own.
Over time, however, they create a distorted picture of how the business is actually performing.
In this particular case, there was another problem. The owner had not allowed for tax. They were looking at the bank balance and making decisions based on the cash available today, rather than the commitments that were sitting quietly in the background.
When we looked at things and the picture became clear it became obvious the owner wasn't worried so much about profit, they were worried how they were going to pay the tax bill when it arrived.
When tax time did arrive, the numbers and pressure suddenly became very uncomfortable and what looked like available cash wasn't really available at all. Also there was no relationship with the accountant, they just completed end of year accounts and nothing else, so this person felt rather isolated.
Drawings is a common issue in owner-led businesses. The owner feels like the business should be making more money, when in reality the business is funding both the operation and the owner's lifestyle at the same time.
If someone else owned this business tomorrow, how much profit would be left after paying a market salary to run it?
The answer is often very different from what appears in the financial statements and very different again from what the owner feels they are earning.
Understanding drawings isn't about restricting lifestyle or telling owners what they can and can't spend but it is about clarity.
When you understand the difference between profit, cash flow and drawings, better decisions become possible.
You know how much the business is truly earning, you know how much you are taking out, you know what tax obligations are coming and you can make deliberate decisions about all three.
Having good reporting reduces stress, improves cash flow, supports growth, and allows you to enjoy the rewards of success without creating financial surprises along the way.
Because when you understand the true performance of your business, you can make better decisions and better decisions lead to better profitability.
How clearly can you separate your business profitability, business cash flow and drawings?
If numbers are not your thing then build a relationship with your accountant or advisor before you need them. The days of flying blind are long gone and there shouldnt really be any surprises when it comes to profitbility, cashflow or tax these days.
The problem is not drawings in itself, but taking drawings without understanding some key fundamentals:
A well-run business can support significant drawings but a poorly understood business cannot. The distinction matters, because when you run out of cash or can't meet your tax obligations life get's pretty tough.
PS: The person above got their tax position sorted, got a handle on profitabilty & cashflow and managed to turn things around before it was too late.
