S-Corp: Accounting for Owner's Draw (Distributions)

June 24, 2021

by a searcher from Harvard University - Harvard Business School in Boston, MA, USA

Hey Searchfunder community - wondering if anyone has come across this scenario before involving an owner's draw (distribution) in an S-Corp being treated as an EBITDA adjustment.

Intermediary has presented an adjusted EBITDA figure accounting for this Owner's Draw as excess compensation, which in some years is quite significant, e.g. ~30% of adj. EBITDA.

My understanding as I read the company's I/S and B/S (and as I did a little supplemental reading on the subject since I'm not an accountant), owner's draw or distribution in an S-Corp is essentially a reduction of the equity account, pulled out of retained earnings. It does not appear on, nor does it have an impact on, the Income Statement. Even so, this intermediary is treating it as an EBITDA adjustment.

Is this adjustment BS and the owner is just pulling accumulated cash out of the company that has nothing to do with its in-year profitability, do my accounting skills still need more work, or is it somewhere in between?

Reply by an intermediary
from Boise State University in 800 W Main St, Boise, ID 83702, USA

I agree with Ron Buck's and Mike Adhikari's comments. Here's my two cents. Think of distributions as cash taken from the business checking account by the owner. Cash gets into the bank account from retained earnings (after debt and taxes). Thus,, a distribution reduces equity and it reduces cash (or increases debt) since assets must equal to the sum of liabilities and equity. For example, if there wasn't enough cash in the bank to cover the distribution amount, the distribution would have to come from a debt increase such as a line of credit or increase of a term loan. I've seen this happen when sellers/owners have made distributions in excess of its earnings for the year. The owner typically looks at me with surprise not understanding until I walk them through the numbers. As the others have said, it is not possible to add back distributions to EBITDA because a distribution comes from EBITDA.

Reply by a professional
from University of Minnesota in Minneapolis, MN, USA

If the company is recording the owner's draw as a distribution, it would only be impacting the balance sheet. In that scenario, there should not be any EBITDA adjustments for excess compensation, unless in addition to distributions, the owner is also paying themselves an over market salary. It is certainly common to see EBITDA adjustments for excess compensation, but that should only be included if the company is originally reporting that compensation on the income statement.

Feel free to reach out to me if you would like to discuss further at redacted

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