Altruistic ambitions aside we are all in business to make money. Money isn’t everything, it’s all there is as the saying goes. For many people starting new businesses, the money starts coming in and they are not clear on how much they should pay themself. If this state of affairs carries on the business soon suffers. So we need to have a little discussion about how much you should pay yourself. This is not limited to new businesses only, at any stage or scale this is a really important question to answer.
We won’t through the obvious benefit of having money in your pocket. Nice as it is there are other benefits for your business involved with knowing how much you should and will pay yourself.
Real running cost of business
Firstly knowing the real running cost of your business. In my experience with freelance accounting and bookkeeping, I’ve come across many situations where small business owners did not award themself a salary, had a business which was doing great but struggled financially at the same time. After some digging and consultation what emerges are muddled finances between the owner and the business. There was no clear distinction drawn between the two and as a result, the true running costs of the business were unknown. Having a clear picture of what you pay yourself shows the true running costs of the business.
Shows investors seriousness but…
The other great thing that working out a salary for yourself does when put into the business plan is it shows potential investors how serious you are about the success of the business. War stories of Steve Jobs and his $1 a year salary aside tying yourself to your businesses’ success is a good sign to those who want to join or finance the business. It shows that you have a desire for it to succeed beyond looking good. It gives you a concrete reason to hit targets which matters to those who want to partner with you.
It’s not going to be as easy as me telling you to pay yourself US$400 or the equivalent. I don’t know your business. What I can tell you are the right questions to ask yourself to determine how much you should pay yourself. Here they are below.
How much are we making?
First things first what is your revenue like. You cannot pay the money you don’t have. If you can drill down to profit that’s better but the reason I mentioned revenue is that profit isn’t as simple a figure as its made out to be. While everybody can clearly see profit per unit there are other operating costs outside of product that need to be considered. So you will often get people who come to you saying their business makes a profit when they are looking at gross profit. It’s best to have an idea of the activity level at which you can pay yourself a salary.
how much are others like me paid?
What do people in similar roles to yours get paid? This is not expecting your small business to match industry titans but it is something well worth considering in the process. Your qualifications, skills, expertise and experience do of course have a value and that value should be somewhat if not completely compensated.
How much do you NEED?
This question and the next one are pretty much two sides of the same coin. Things are tough in Zimbabwe. Nobody will fight you on that. You need to work out how much you need. Without a personal budget and financial plan, it will be very hard for you to work out how much you could accept. So sit down and draw up a plan of how much you need.
How much do I want to reinvest?
The other side of the coin is how much does your business need? Well not exactly but bear with me. If your business is profitable it stands to reason that putting more money into it will bring back more money unless you have plateaued. So with this in mind, every cent you take out of the business has the opportunity cost of what the business could’ve done with that money. Reinvestment is the other side of paying out money. The more you pay out the less you have to reinvest.
How do I want to pay myself?
Finally, how will you pay yourself? You have the option of paying yourself a salary or drawing as an owner of the business. If you have a sole proprietor or partnership structure this is referred to as drawings while in a company structure as dividends. We will just use the term drawings. The thing you will have to pay attention to is where the different methods come in. Salaries are a tax-deductible business expense before profit where drawings are reduction in business equity by the owner. From your perspective as an individual, it is largely the same but the two treatments have different effects on the business.
With those four questions answered you now have an idea of how much you should pay yourself. Don’t stop there, there is more to think of. One great way is to pay yourself a percentage of net profit (after all expenses). This is pretty much a drawing but it ties the success of the business to performance. A fixed salary can hurt the business in times of lower activity though it protects the individual. But not for long.