For some sole proprietors, there is confusion between the money taken out for personal use (Owner’s Draw) and the Net Profit earned by the business. One is taxable and the other is not. Let’s clear it up now. First, read my article, “Understanding the Bottom Line”. As I mention in the article, there is a loose correlation between the two. However, the Internal Revenue Service is only interested in your current year earnings (Net Profit), not how much money you withdrew from the company. You may have been able to draw the money out of the business because most of the money came from net profit, but some of that money may have come from other sources.
The other concept the article addresses is the fact that the Profit and Loss Statement is an extension of one line item in the equity section of the Balance Sheet. Net Profit usually means and increase in Equity, and Net Loss means a decrease in Equity. That seems to stand to reason. Perhaps you hadn’t yet made this connection. If so, then you have just increased your knowledge base of how accounting works.
Let me know if you have any questions or need any clarification.
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