Please Note: This guide applies to Sole Traders and Partners of Non-Limited Companies, if you are a Limited Company please refer to the guide here:
“How do I account for business expenses that I have paid for out of my own pocket?”
We’ve covered this subject in detail within the forum but have decided to distill all the key points into one single guide.
An offshoot of this is if your business is unlucky enough to run into financial difficulty, it will also rest on your shoulders as the proprietor to pay the bills, i.e. you don’t have limited liability.
As a sole trader or partner the profit and loss (P&L) report is really the backbone of your accounts. Anything else, i.e. drawings and personal expenses is of little importance.
Method 1 is great if you’re running all your business transactions through your personal account, deleting entries on your bank however will mean that you won’t be left with an accurate bank balance, but as we’ve previously established that doesn’t really matter in the case of sole traders and partners, least of all if it’s your personal account.
Method 2 allows you to preserve your bank balance and explain any drawings or personal expenses as a single bank transfer to the Proprietor Drawings Account. This is more suitable for those with an actual business bank account. As a sole trader you should strive to use method 2 along with a dedicated business bank account, unless your business activity is infrequent and mixed in with our personal transactions.
For Method 1 we would just enter the part that qualifies as a business expense and ignore the rest. You can do this either by creating a new purchase invoice and entering only the amount relating to the business, or you could instead locate the relevant entry on the bank, delete it and replace with the partial (business expense) amount, and then tag to a purchase invoice. The net effect will be the same.
In the case of Method 2 you would again create a purchase invoice with just the business expense amount and pay that from your bank account. If you then want to preserve your bank balance enter the difference of the invoice total (which is the personal part) and tag that part to Proprietor Drawings Account.
When it comes to personal expenses and drawings you can either delete the entry on your bank or tag it to the proprietor drawings account.
Disclaimer: This article is for general guidance only and does not substitute professional advice relating to your own specific circumstances.