Small business owners need cash to breathe life into their companies. Between starting and growing a business, paying for rent or mortgage and equipment, marketing, and more, it's hard to keep up with an ever-growing list of expenses. And, you need money for yourself. Use these tips to understand how to make sure you can pay yourself what you deserve.
The first two things to always keep in mind when answering this question are to make sure to pay yourself enough to get by, and what you're worth.
At least during the startup phase, until you are operating in the black, pay yourself just enough to get by. The argument here is to minimize your overhead to decrease the amount of capital needed to make your business a success. Also, by reducing your overhead, your net loss will fall, or your net profit will increase, giving your business lean operating cost requirements until it is well established.
Build a salary for yourself in your business plan, so you have an accurate portrayal of how much capital you will need to finance your business. By paying yourself what you are worth, you aren't painting an artificial portrait of the business that will change once you reach the black -- so your operating costs will remain the same.
Let's face it. You didn't start a business to eat microwavable macaroni and cheese and peanut butter sandwiches for the rest of your life. You may not have enough to pay yourself as much as you want now, but it's a good idea to start planning.
Planning future wages is also an excellent opportunity to calculate how many customers you need to reach the salary you want. This will not only help you create attainable goals but will also help you determine your prices.
So how do you know what is enough to get by, and what you are worth? You have to do some planning and simple mathematics, and then budget that amount into your financial plans to know how much capital you'll need during the beginning stages of your company's development.
What happens when you reach break-even and grow beyond that point? Many factors go into the equation, such as a legal form of operation and tax requirements. You need to balance your needs against what you feel you are worth, what you need to get by, what the business will be able to sustain, and how your income will be taxed.
If you're the owner of a sole proprietorship, partnership, LLC, or S Corp, you're generally just going to take the company's profits and invest it back into the business or income. Whether you pull that money out of the company or not, you'll be taxed on it in the year.
If your company is registered as anything but a sole proprietorship, you may choose to pay yourself a salary. If your tax rate is lower than the company's, it makes sense to pay its full profit to yourself as a salary. If not, you'll want to take out a reasonable amount and leave the company the rest.
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 IRS, you should pay yourself "reasonable compensation." That is an abstract, imprecise term. How do you determine what reasonable compensation means?
The IRS states that "Wages paid to you as an officer of a corporation should generally be commensurate with your duties." 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.
Even if you aren't required by law to pay yourself a salary, it's a good idea. Making sure you're compensated for your work is important for you and your company.
Without factoring in your salary into expenses, you won't know if you need to raise prices, market more, cut costs, or make other adjustments to help your company succeed. Your salary factors into your return on investment and will change a lot.
And as for the amount, treat yourself like you would any other employee. If you were to hire someone to do your job, what would you pay them? That's the amount you should pay yourself.
Essentially, when determining what to pay yourself, be honest about what you need and what the company needs. You shouldn't be starving, but you shouldn't be preventing company growth by going on vacation.