Making money is probably one of your main goals when starting your business. But in some cases, especially when starting out, money can end up mostly being reinvested into the business. Even when business owners begin to pay themselves, they may not understand how much they should pay themselves in order to make the business sustainable.
We’ll look at the different ways of paying yourself, how to decide on how much is enough based on a range of criteria, and how to ensure you’re striking the right balance between funding your business and meeting your own personal needs.
1. Understand the Different Ways of Paying Yourself
There are various approaches you can take when paying yourself. The method you choose will depend on various factors like how often do you want to get paid, the type of business you run and which solution is tax-efficient for you.
- Owner’s Draw: When you take a “draw” from the business, it’s a simple, one-off distribution from the company’s accounts to your own. Don’t think of it as simply writing yourself a blank cheque, however. It has to be accounted for, just like any other payment. It will be taken out of the “owner’s equity” account on the balance sheet.
- Salary: It’s the way that most regular employees get paid, receiving a paycheck for the same amount every month or other agreed-upon period. As a business owner, you can also pay yourself a salary for the work that you do.
- Dividends: A dividend is a distribution of some of the profits from the company to its shareholders. Dividends are typically paid on a regular schedule, such as once or twice a year, and tend to be linked to the level of profit. If you own the company outright, you’ll be the only shareholder, so dividends will go only to you. If you have partners or investors who own equity stakes, they’ll also be entitled to dividends when they’re paid.
Also note that dividends can only be paid from retained profits, so you’ll have to make sure that the company has accumulated enough profit to pay out the dividend. It’s OK to pay out retained profits from prior years, even if you made a loss this year.
2. Pay yourself from Profits not Revenue
Just because there is money flowing into your business, does not mean that it should all be taken out. There are still other business expenses such as office rent, employee salaries and taxes to be paid. Thus, it makes more sense to pay yourself from the profit gained after paying all business expenses due.
3. Do not pay yourself all the profit.
Have surplus set aside to make the business run in the cases where there is a decrease in cash flow. Just because there is profit in your business, does not mean it is all yours to pay yourself. How much should you pay yourself?
One approach is to look at the competitive landscape. Look around and check how much people are paid in your industry. Another option is to pay yourself a percentage of the profits. This does not mean that your salary will fluctuate per month based on the profit, you can also base it on your profit forecast for the whole year.
When setting the amount, it’s important to get the right balance between meeting your own immediate needs and investing for growth. You don’t want to put financial stress on yourself, but you also want to leave enough money in the business to fund its growth.
4. Always pay your employees first.
Certainly, your employees need to be paid before you. If their paychecks have been delayed and they see you happily collecting yours, you can expect to see them to send their resumes out to other firms before the day is out. Similarly, if you’re falling behind with loan repayments or unable to pay supplier invoices, it’s probably a bad time to be taking out money for your personal use.
Conclusion
Paying yourself from your business is a key activity that if done well, helps in ensuring the business runs well in a sustainable way. As outlined above, consider the various factors before deciding on paying yourself.
