As a business owner, you need to get paid for the work you are putting in. And that needs to be at market rate. Deciding how you get paid can be tricky, especially when it comes to understanding the difference between drawings and taking a regular PAYE salary.
What Are Drawings?
Drawings are funds you take out of your business for personal use. It’s essentially like transferring money back and forth between you and your business.
A few examples of drawings
1. When you pay a personal expense on your business, i.e. you forget your personal card at the supermarket and are forced to put the purchase on the business card – this purchase would be coded as drawings. This should be once in a blue moon! Personal and business money should always be kept as separate as possible.
2. A builder is working on his own house, but he uses his business accounts to purchase materials for his personal house. These one-off personal purchases paid by the business are marked as drawings. These should not happen often by the way, otherwise you are at risk of overdrawing.
3. Many businesses need a lot of capital in the beginning, and often this is personal funds, this is also drawings (usually referred to as funds introduced).
4. Each year you may have a bit of drawings/funds introduced that go back into the business via your home office expenses (that you pay for personally) or another couple of examples are your mobile phone or car.
You can think of drawings as a pot, where you put money in, and take it out. When you overdraw on your pot (so you take more money from the business than you have put it) – this can make cashflow bumpy, plus you can be taxed on these drawings (as you are taking profits) so you need to be disciplined enough to save the tax.
You can take regular drawings from your business account, as a type of salary – for example, you may set up an automatic payment from your business to your personal bank account of $1000.00 per week – and this is your ‘earnings’ from your business.
Drawings aren’t taxed directly, but the business profits they come from are.
Can You Take Drawings Without Profit?
Yes, but it means you’re withdrawing from your business’s capital or reserves/equity, not profits. This can affect your cashflow and financial stability, so manage it carefully.
What is a PAYE Salary?
Most people are more familiar with PAYE (also known as salary/wages/earnings). If you have ever been an employee, chances are you earnt PAYE.
PAYE stands for "Pay As You Earn," and it involves regular payments (e.g., monthly, fortnightly, or weekly) with income tax and other deductions like KiwiSaver, student loans, and child support, handled automatically through your business’s payroll system.
Key Differences Between Drawings and PAYE Salary
Structure
Drawings are flexible and can be taken as needed (making it a bit irregular for your personal budgeting!).
A PAYE salary is fixed and regular.
Drawings can be more useful, if your business is newer and cashflow is bumpy. Once you start taking a PAYE salary, you can’t really start and stop it, you are also obligated to pay the tax straight away.
Tax Treatment
Drawings are from business profits (or existing reserves) and aren’t taxed directly. However the profit will be taxed and so you need to keep tax savings aside when taking drawings. A lot of discipline is needed.
PAYE salary is taxed at the time of payment.
Record-Keeping:
Drawings require meticulous records.
PAYE salary needs a payroll system for tax deductions.
Two Real-life Examples
Sally has recently opened a new pottery business – she is selling pottery part-time, while she has young kids at home. Her husband earns a large salary, and receives PAYE as an employee. He is paid fortnightly. Because Sally’s business is new, and she’s having to invest a lot of the profits into new materials, she also doesn't have the pressure of having to bring home the bacon. She takes some pocket money (drawings) from the business each month, once her bookkeeping is complete and she knows what is leftover. She remembers to put some of these drawings in a separate bank account for her tax bill.
Matt is a builder and he is also saving for a house. He has been an employee all his life, but as of a year ago, he opened his own building business. In the last year, he has built up a good client base and has regular work. Matt is not very good at saving for his tax, he puts aside what he needs to save for a house, and he spends the rest – he likes to have a similar lifestyle that he had before going out on his own. Matt has set himself up on PAYE and only takes that salary from his business. Once his accountant has completed his year end, Matt should be able to take a bonus (putting the tax aside) as-well.
Which One is Right for You?
The choice depends on your business structure, cashflow position, personal budgeting style, and lifestyle. There’s a lot to consider, as a business owner, you must understand drawings and PAYE. Each method has its benefits and choosing the right one depends on your business needs and personal financial goals.
It’s an excellent idea to consult with a bookkeeper or accountant to determine the best approach for your situation.
If you would like to chat through your situation, and what would be best for you, please book a call.
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