The effect of financial transactions on the accounting equation

 




 

 

 

 

 

 

The effect of financial transactions on the accounting equation will be explained by looking at a series of business transactions for a newly-established sole trader’s business.



Drawings
The owner or owners of a business can draw out the profits that the business makes. If they wish to do so, they can draw out all their profits. In practice, however, owners usually draw some profits and leave the rest in the business, to finance the growth of the business.
 Profits that are kept in the business are called retained earnings.
 Profits that are drawn out of the business are called drawings, in the case of businesses owned by sole traders or partnerships. Profits paid out to the shareholders of companies are called dividends.
Drawings are usually in cash. However, an owner might take out some inventory
from the business for his own personal use, or even a larger asset such as a
motor vehicle. Taking inventory or other assets is a form of drawing, as well as
cash.