Bookkeeping

How Much Should A Small Business Owner Pay Himself?

The entrepreneur salary—it’s a number that’s both thrilling and complex. I still remember the day I got my first paycheck from my after school job. I immediately went to the bank, cashed it, and headed straight to the mall.

There was something so rad about getting a piece of paper that magically turned into cash that magically turned into an epic feast at the food court.

Getting a paycheck is SUPER rewarding. Yet, some small business owners don’t get the reward of a steady paycheck. Instead, we get the frustration of continually asking ourselves, “What should my salary be?” And then we have to figure out how to divvy up our money between our business and personal bank accounts.

But you can climb out of the business owner salary fog. Here’s my holistic method for calculating owner pay, along with a free salary calculator that will help you land on the best number for your situation.

In 2018, Justin Bajan gave up a cushy six-figure job as a copywriter to launch his ad agency, Familiar Creatures. It was a big change — he, his wife and three kids packed up their minivan and moved from Boston to Richmond, Virginia, where his business partner lived and where he used to work.

Although they had one client, a local brewery, it was far from certain whether this venture would work out or if he’d ever earn the kind of money he was used to making again.

Still, he couldn’t resist the entrepreneurial pull. “We saw there was an opportunity to work with a certain calibre of the client, but without the outdated structure that most agencies exist within,” he says. “And I’d rather be doing something entrepreneurial and see where it goes and how it grows than be nice and comfortable with nothing to show for yourself.”

For many, the chance to set your salary sounds like a dream come true. But small business owners know the reality is a little more complicated.

You should only pay yourself out of your profits – not your revenue. When you see money coming into your business, don’t assume you can pay yourself a big slice of that. Before you take your cut, you also need to take account of things like taxes, payroll, fixed costs and overheads.

Good accounting software will help you work out how much you can afford to pay yourself. It will let you keep track of all expenses and calculate profit rather than revenue or turnover. It will also help identify areas you can make tax deductions.

Setting your salary will depend on your location, your industry, your profits, and how much you want to earn. But there are a few things to think about that can help you land on a reasonable figure.

It’s an age-old problem that faces every entrepreneur planning their business: What do I pay myself?

When you’re thinking about your business expenses, one of the easiest items to overlook is your own salary.

According to the 2016 American Express OPEN Small Business Monitor, just over half (51 percent) of business owners pay themselves a salary. But Alice Bredin, a B2B marketing entrepreneur and small business adviser for OPEN, emphasized the importance of including your own pay in the budget as soon as you can afford to do so.

“Compensating yourself is important for you and your company,” Bredin told Business News Daily. “If you are not allocating funds for your own salary, your books do not accurately reflect the health of your company, since your expenses are missing a large cost, namely you. Without factoring in all expenses, you won’t know if you need to raise prices, market more, cut costs or make other adjustments that will help your company succeed.”

“Some entrepreneurs work for free for much too long,” added Evan Singer, president of SmartBiz, a provider of Small Business Administration (SBA) loans. “It’s no surprise that anxiety and worry about personal finances are not conducive to building and running an enterprise. If you’ve established a small business, it’s important to realize that your time is valuable.”

There’s also a practical reason to pay yourself as a small business owner: Depending on the structure of your company, you may be able to give yourself a tax break if you designate a personal salary out of your total business income.

“Let’s say you’re making a net income of $100,000 a year in your business, and you file as a sole proprietor: Self-employment tax — which consists of Social Security and Medicare — will be calculated from the full $100,000,” said Whitney Delaney, founder of Delaney Tax and Wealth Management. “On the other hand, if you’re an S corporation and you pay yourself a salary, your [deductions] will be based [only] on your salary rather than your total net revenue.”

 

How to Pay Yourself as a Business Owner

How Much Do Entrepreneurs Make?

Unlike the typical 9-5, an entrepreneur salary can come in many forms. The IRS requires different types of owner compensation based on how the business is structured. Generally, there are two main ways that entrepreneurs pay themselves: through a salary method (like a typical payment structure) or an owner’s draw method (where the owner draws from the company’s profits).

Anyone who hasn’t been a business owner may romanticize the idea of “being an entrepreneur.” It’s easy to picture glamorous CEOs who have it all together and take home large salaries. But if you have been an entrepreneur, you know the life of a business owner is rarely that simple, especially when it comes to a small business owner’s salary.

Whether you’re just getting started or you’ve been in the business for years, you’re probably constantly asking yourself—should you be taking a salary?

In a word: Yes! Well, probably. At least to some extent.

Jump to our infographic to learn how much entrepreneurs should pay themselves. Or, keep reading to learn the finer points of the entrepreneur salary, so you can breathe easy that you’re not screwing up this business owner thing—and know that you’re 100% not alone.

You may have any number of reasons for starting your own business – doing something you love, being your own boss, creating a venture you can pass onto your children, or something else entirely. But at the end of the day, it’s a business, and you’re trying to make a living. That means you have to get money out of your business somehow. Many small business owners have a hard time deciding how to do that and how much to pay themselves. It can be a tough number to pin down – too much, and you may jeopardize the financial health of your company, too little and you jeopardize your own finances.

 

Why Business Owners Should Pay Themselves First?

“Pay myself first? I can barely pay myself at all, let alone do it first!” If that sounds like you, you’re not alone. Many business owners struggle with the “pay themselves” issue every day. But let’s state the obvious here: even business owners have to eat.

You likely started your business so you could pursue a venture that you love while (eventually) making money doing it. It takes some effort, and some creative accounting, but the rewards of paying yourself first are well worth it. Let’s explore why this is so critical.

Cash Flow

 

Why it matters what you pay yourself as the business owner.

Business owners often don’t pay themselves at all but draw money out of the business account when they need it. At the end of the year, the accountant adds up all the “draws” and books it to something appropriate in the balance sheet to make the Tax Department happy, and it’s all good. So why does it matter how much you pay yourself, why should you pay yourself at all and how much should you get paid?

Clearly, a big factor in how much profit your business makes and whether or not the business has the cash to pay its bills is how much money you draw out of the business at any one time. If your business turns over half a million dollars and you have 4 employees and an office, and you pull out $200K yourself every year there may not be enough money left to pay for Cost of Sales, staff wages and overheads (or tax, for that matter), and if you pull out nothing at all, it might look like your business is enormously profitable. Your wages, drawings or dividends are a significant factor influencing the health of the company.

So wat’s wrong with letting your drawings depend on whether there’s enough money in the bank to pull some out?

A healthy small business ought to make somewhere north of 5% net profit before tax, every year. I generally advise my clients to aim around 10% as a guideline. (10% of revenue… so for every $100 in sales, the business ends up with $10 of net profit). There is no golden rule about this number, but it’s a useful guideline in most cases.

 

Should I Pay Myself a Salary?

You may decide to pay yourself a salary, rather than take a draw. One advantage of taking a salary is that tax withholdings and benefit payments come out of your gross pay automatically.

 

Why Should an Entrepreneur Take a Salary?

You’ve probably worked harder at launching your business than you ever have at any other job in your life. It’s a 24/7/365 thing that never ends. And you’re lucky if you get to think about anything else. You’ve poured blood, sweat, tears, and who knows what else into making this dream a reality. It might not be perfect yet, and you might not have it all together—but you need to at least plan to receive some compensation for it.

What’s important to know is that there isn’t just one type of entrepreneur salary. And there’s no precise equation for determining how entrepreneurs should pay themselves, as the right choice varies dramatically by your business type, age, financial health, and more.

But this all means that different approaches are depending on your kind of business. With different types of entrepreneur salary options for business owners, there are pros, cons, and legal implications of how and when to take a paycheck. All of them can help you decide exactly how much you should be paying yourself.

 

Add yourself to the payroll and pay yourself regularly.

Don’t just dip into your business funds as and when you need to. Set up payments for you and your employees (it may be weekly or monthly) in your payroll software, and stick to them.

Build that into your business plan right from the start, perhaps with a rising salary as your business grows. That way you’ll get used to the amount of money you receive and won’t have to worry about taking out occasional large lump sums.

This will also look better to your employees. Regular small payments will be more acceptable to them than random large lump-sum withdrawals from the business. They will also look more acceptable to the government. If you take out big sums of money at varying times, it may raise eyebrows at the tax office or lead to an audit of your company.

 

How Can You Pay Yourself First?

Even if you’re still in the startup phase and living off personal savings, paying yourself from the beginning has decided advantages you can’t afford to miss. Paying yourself can have tax benefits, as well. Check with your accountant to see what benefits to which you may be entitled.

Here’s why you need to pay yourself a weekly, biweekly, or monthly salary:

  • Paying yourself is an added work incentive. It feels great to get money in return for hard work, even if it’s a small amount.
  • Spending yourself increases savings for you or the business.
  • Investors view business owners who pay themselves as highly committed – so do banks and finance companies.

 

How Much Salary Should You Pay Yourself?

Now that you know the options for paying yourself, you face the big question: how much? Of course, the answer depends on several factors.

According to the ATO, “reasonable compensation is what you should pay yourself. That is a nebulous, imprecise term. How do you determine what that means? The IRS states that “Wages paid to you as an officer of a corporation should generally be commensurate with your duties. Refer to “Employee’s Pay, Tests for Deducting Pay” in Publication 535, Business Expenses” for more information. In other words, you’ll need to give yourself a market wage.

In general, a market wage is a good idea. That means you know how much pay to expect and that your company is running comparably to others. If you can’t cover a market wage, your company may not be running efficiently. If you have way more cash than you need, you may be missing opportunities for growth.

Look at other people doing similar work in your area and pay yourself similarly. That’s it – there’s no hard math, just a general number range for the same kind of work.

Even if you aren’t required by law to pay yourself a salary (market or otherwise), it’s a good idea. In the words of Alice Bredin, a B2B marketing entrepreneur and small business adviser for OPEN, “Compensating yourself is important for you and your company,” Bredin told Business News Daily. “If you are not allocating funds for your own salary, your books do not accurately reflect the health of your company, since your expenses are missing a large cost, namely you. Without factoring in all expenses, you won’t know if you need to raise prices, market more, cut costs or make other adjustments that will help your company succeed.”

Before jumping up and down clapping your hands about getting a paycheck, take a long hard look at the numbers. Revenue and profits are not the same things. You have utilities, employee salaries, tax obligations, and other bills to pay that cut into revenue.

Don’t just look at the current numbers, either. There may be future expenditures, such as estimated taxes that have to be paid. Look at accounts receivable to see how much money will be coming in. It would help if you also took into personal account expenses. Your rent, mortgage, food, credit cards, car loans, and living requirements have to be totalled and assessed.

There are two choices when it comes to deciding how much to pay yourself. The first is paying yourself enough to get by. If you’re still in the startup phase and not making much profit, reduce your overhead as much as possible. Pay yourself a small but steady amount.

Car Tax Deduction

As your business grows and your profits increase, you can look at paying yourself what you think you’re worth. What do professionals make at similar-sized local companies in your region? Don’t compare your potential pay with that of the salaries of execs in New York City if you live in Duluth, Minnesota. Trade associations, local small business organizations and other industry entrepreneurs often offer comparable salary information.

Keep in mind that the Australian Taxation Office requires you to pay yourself “reasonable compensation.” Pay yourself too much for someone in your field and location, and up goes the ATO red flag.

If you haven’t already, invest in accounting software to keep track of all of your business transactions, including your pay (Ask your accountant which software program best fits your business structure). Pay yourself consistently – the same day and time every month, and make sure these entries are made in the accounting software.

The amount you pay yourself has a lot of variables. As a business owner, you have the freedom to determine your salary. As your profits grow, evaluate your salary the same way you would an employee’s. You have the power to pay yourself more when profits are high and less during economic downturns or when expenses arise.

Business owners pay income taxes and self-employment taxes using either a salary or a draw. Your compensation decision should be based on how much money your business needs to operate moving forward, and if you’re willing to do more personal tax planning by using the draw method.

 

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