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3 min 56 sec
0:00
Where repayments go
0:26
Interest and principal
0:50
Two different places
1:23
Paying yourself: sole trader
1:52
Paying yourself: company
2:23
Loans in Beeswax
3:00
Recap and quiz
Accounting 101
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Keeping it straight
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Episode 23
Loans and Owner's Pay
(Interest, principal, and paying yourself.)
Maya's loan repayments are part interest, part principal, and they go to different places. Plus how she actually pays herself, as a sole trader or as a company.
loans
interest
drawings
owner's pay
Transcript
0:00
Back in episode one, Maya borrowed five thousand from the bank. Every month since, three hundred has left her account. She'd assumed that was three hundred off the loan. The bank had other ideas.
0:13
Today: loans, and how owners pay themselves. Two things that confuse almost everyone. Including, for a while, Maya.
0:26
A loan repayment is usually two things wearing one coat. Part of it is interest: the price of borrowing. The rest is principal: actually paying the loan back.
0:38
Of Maya's three hundred, fifty is interest, and two hundred and fifty is principal. And the split changes over time. As the loan shrinks, the interest shrinks with it.
0:50
They go to completely different places. Interest is an expense. It reduces profit. Debit interest paid, fifty.
1:00
Principal isn't an expense at all. It just reduces what you owe. Debit the loan, a liability, two hundred and fifty. And credit the bank, the full three hundred.
1:12
Put all three hundred through as an expense, and you'll understate your profit. And your balance sheet will think you still owe the full five thousand. Forever.
1:23
Now, the bit everybody actually wants to know. How does Maya pay herself?
1:28
It depends how the business is set up. As a sole trader, Maya and the business are, legally, the same person. She can't pay herself a wage. She just takes money out. That's called drawings.
1:42
Drawings aren't an expense. They don't reduce profit. They reduce equity: the owner's share of the business. Debit drawings, credit the bank.
1:52
If Northlight were a company, it'd be different. The company is its own legal person. Maya could be paid a salary, through payroll, and that's an expense. Or she could take dividends, a share of the profits after tax, which come out of equity.
2:09
Which mix is best depends on the tax rules where you are, and they change more often than anyone would like. It's the classic conversation to have with your accountant. Ideally before the year ends, not after.
2:23
In Beeswax, a loan lives in a liability account. When a repayment comes through the bank feed, record it as an expense with two lines. Interest paid for the interest, and the loan account for the principal. Expense lines can use liability accounts too.
2:41
For drawings, add an equity account called owner's drawings, and allocate the money Maya takes out to it. It shows on the balance sheet, not on the profit and loss.
2:52
And a company director's salary goes through payroll, just like Priya's, for Australian and UK accounts with the payroll add-on.
3:00
So. A loan repayment splits in two. Interest is an expense. Principal reduces the loan. Sole traders take drawings, straight out of equity. Companies pay salaries, which are expenses, or dividends, out of profit. And drawings and dividends are never expenses.
3:21
Quick one. A four hundred loan repayment. Sixty is interest, and three hundred and forty is principal. How much reduces profit? And how much reduces the loan?
3:32
Have a think.
3:36
Sixty reduces profit. Three hundred and forty reduces the loan.
3:42
Maya now reads her loan statement every month. She describes the experience as character building.
3:48
Next time: the profit and loss. Northlight's first full year, line by line. Brace yourself.