What Is a Draw Check and How Does It Work?

A draw check advances funds against future earnings, a pre-approved credit line, or a specific project budget. Unlike a standard check, it provides liquidity or manages expenses before the full amount is earned or disbursed.

Understanding the Concept of a Draw Check

A draw check functions as an advance of funds, sourced from a pre-arranged credit facility, loan, or anticipated future revenue. Unlike funds in a checking account, money accessed through a draw check is not yet fully owned by the recipient; it represents an early release of capital based on a prior agreement.

A standard check clears funds already present in the drawer’s bank account. In contrast, a draw check accesses funds from a larger, often unearned, pool of money, functioning as an early distribution. This allows recipients to receive money ahead of the typical earning or disbursement schedule.

Key parties in a draw check transaction are the issuer, who provides funds, and the recipient, who receives the advance. For example, a lender is the issuer and a borrower the recipient in a loan scenario. An employer might also be an issuer providing an advance to an employee. The governing agreement specifies terms, conditions, and repayment methods.

Common Applications of Draw Checks

Draw checks are utilized across industries to manage cash flow and provide capital at specific project or earning stages.

Construction draws are a common application where funds from a construction loan are released in stages as project milestones are met. This systematic disbursement ensures money is allocated for completed and verified work, rather than a single lump sum upfront. After a contractor completes a phase, such as foundation work, an inspection confirms progress. Upon lender approval, a draw request is submitted, and funds are disbursed to cover costs for that phase, including materials and labor.

Commission draws provide sales professionals an advance against future earnings. Sales compensation often relies on commissions, which can be inconsistent or subject to lengthy sales cycles. To provide stable income, employers may offer a regular draw amount, reconciled against actual commissions earned over a specified period. If earned commissions exceed the draw, the professional receives the difference; if they fall short, the deficit may be carried forward or treated according to the employment agreement, often as a recoverable advance.

Other loans frequently utilize draw mechanisms, especially revolving lines of credit. Unlike traditional term loans that disburse a single lump sum, a line of credit allows borrowers to access funds as needed, up to a pre-set credit limit. Borrowers can draw funds, repay them, and then draw again, providing flexibility for ongoing operational expenses or fluctuating capital needs. This draw type is common for businesses managing working capital or individuals with home equity lines of credit.

Financial and Accounting Treatment of Draw Checks

The financial and accounting treatment of draw checks varies for the recipient and the issuer, reflecting the advance’s nature as an asset, liability, or equity reduction. Proper recording is crucial for accurate financial reporting and tax compliance.

For the recipient, a draw check is not immediately recognized as earned income; instead, it’s treated as an advance or loan, creating a liability on their financial records. A sales professional records a commission draw as an advance against future earnings, becoming earned income only when commissions are realized. Similarly, a borrower receiving a construction draw recognizes it as a loan payable, increasing liabilities until repaid or converted to permanent financing. On a pay stub, advances might be delineated from regular wages.

For the issuer, accounting treatment depends on the draw’s nature. An employer providing a commission draw records it as a receivable or asset, representing funds owed back by the employee through earned commissions or direct repayment. For a lender, each construction draw disbursed adds to the loan receivable balance, an asset on their books. An owner’s draw from a business, common in sole proprietorships or partnerships, reduces owner’s equity and is not a business expense.

Repayment or reconciliation of draw checks occurs according to the initial agreement. For commission draws, the advance is offset against earned sales commissions. If earned commissions exceed the draw, the balance is paid out; if less, the deficit may carry over or require direct repayment, depending on if it’s a recoverable draw. Construction draws are reconciled as the project progresses and completes, with the total loan eventually repaid through property sale or refinancing into a permanent mortgage.