You are probably reading this article because you’ve started your own business so that you can do what you love and earn some money from it. You may be an entrepreneur in the beauty industry, the proud owner of a small nail salon or beauty parlour.
But even if not, small business owners have roughly the same difficulties and uncertainties. For instance, you may have wondered by now how much should you pay yourself. Break your neck to make ends meet or pay more and risk the endurance of your small business?
Tough question, but we think that it’s possible to strike the right balance. That’s why we put together this little article that may help you make the right decisions so you can keep your business stable but won’t have to be down on your uppers.
Step 1 – Calculate your Monthly Net Income
Setting your own salary may sound like a dream come true for many people, but the truth is: it’s not all beer and skittles. Yeah, when you have a relatively large amount of money flowing into your business, you might think that you can cut yourself a big slice of it.
But this money is your revenue, not your profit, not your monthly net income. Before taking your share, you first have to consider things like the salaries of your employees (if applicable), taxes, fixed costs and overheads.
So basically net income is the amount of money that remains after you’ve subtracted all business expenses from your gross revenue. The formula for this is pretty simple:
Gross Revenue – Business Expenses = Net Income
This certainly isn’t the difficult part: accounting and bookkeeping are. Since you most probably can’t afford to hire an accountant to help you get a handle on your numbers, you alone are in charge of keeping track of all expenses, estimating cash flow, identifying areas where you can make tax deductions, etc.
Fortunately, there are excellent accounting programs like Xero or QuickBooks that can make things a whole lot easier for you by generating instant reports based on various performance indicators.
Step 2 – Set Aside for Taxes
Saving enough for taxes tends to be one of the biggest challenges small business owners face. This is mostly because they only take taxes into account after paying off their loans, paying themselves or – in the case of beauty professionals – investing into a fancy new cosmetic chair or a set of cute gel polish.
However, this approach is not the most fortunate. If your company makes a profit, you just have to pay taxes, that is non-negotiable. Once you accept that, the question of ‘how much should I save for taxes’ arises.
General experience shows that setting aside 30% of your monthly net income should roughly cover federal, state and self-employment taxes. Nevertheless, this could vary depending on the state you live in.
Subtract the amount of your monthly tax savings from your net income, and you’ll get the amount that you personally have access to, as the owner of the business. In other terms, this will be your owner access number.
Monthly Net Income – Tax Savings = Owner Access
Step 3 – Factor in Business Debt and Investments
We’ll get to your payment soon, we promise, but before that, it’s worth considering the subject of your potential debts and future investments, which are essential to running a successful, thriving business. A formula for that would look like this:
Owner Access – Monthly Debt Payments/Reinvestments/Both = Owner Access
Do your calculations with the full amount of your monthly minimum debt payments. You can increase that amount at the end of the process, provided that there’s extra money left after paying yourself. Bear in mind that your loan interest is tax-deductible.
Furthermore, if you’re thinking about reinvesting a part of your profit into your business, we suggest creating a business savings plan. Here’s how:
- Create a list of the things you want to invest in (new equipment, new hires, product launches, website design, rebranding, training programs, etc.) in the future.
- Decide on how much you wish to save for each investment, and estimate the number of months it’s going to take to reach your goal.
- Reorganize your list in order of priority and start saving for the items on it one-by-one.
Goal / Number of Months = Monthly Savings Amount.
Step 4 – Analyse your Personal Needs and Come up with a Number
Once you have completed all the calculations above, you will have the amount that’s available to pay yourself. Now the question is whether it’s enough or not.
To find out, you have to put everything aside and subject your personal needs to a thorough, in-depth analysis. Review your fixed expenses (the ones that don’t change by the month, like rent or mortgage), your variable expenses (expenses that change by the month, like overheads or groceries) and your extra expenses (expenses that aren’t essential for living, like Netflix or eating out).
The best would be if your personal needs number was lower than the owner access number calculated before. If that’s the case, congrats! Hurry and pay yourself that good amount you deserve!
But unfortunately, it’s more likely that your needs cost more than what you can afford to pay yourself. Now’s the time to optimize your numbers a little by changing one or more of the following expenses:
- business expenses;
- debt payments;
- personal needs.
Try to balance things out based on your priorities. If purchasing new equipment is more important than listening to Spotify Premium, cut down your extra expenses number.
Think about these before decidinf on wht to pay yourself
If going on vacation with your family is more important than having a new website design, cut down on your business savings. You can go little by little, that’s okay when you’re trying to come up with a sustainable business owner wage.
If you are at the beginning of your career, your business might not be profitable during the first year. But that’s not the goal, anyway, it’s more like not getting into the red. Nevertheless, all this doesn’t mean that you should not pay yourself.
Not paying yourself for your hard work would be equal to undervaluing yourself which can not only cause financial issues but can also result in emotional instability. Money-generated difficulties are a big source of stress, and stress keeps you from making good decisions both in your personal life and your business.
Depending on what state or country you live in, the term ‘reasonable compensation’ or a similar phrase may apply to you. In the US, the Internal Revenue Service requires from small business owners that they are paid reasonable compensation, which essentially means that even the government wants you to be rewarded for your efforts.
Step 5 – Choose a Payment Method
Now that you know how much are you going to pay yourself, it’s time to decide on a payment method too, a system that’s the best-fitting for the structure of your business. We’ll show you the options.
- This is the most simple form of paying yourself if you’re a freelancer or sole-proprietor.
- Although all the profit you make is yours, it’s always a good idea to open a separate bank account for your personal finance matters and one for business-related transactions, because it will help you with proper bookkeeping.
- If you have an S-Corp or other corporation type businesses, you’re obligated to be paid a regular salary from your business bank account.
- This way, your business will have its own tax return, and you’re required to show ‘reasonable compensation’ for your salary.
- If you own a limited liability company (LLC) or enter into some kind of partnership, paying yourself get a little more complicated.
- With this method, you can draw money from your business account as you see fit. Essentially, you can take company money for personal use.
- Its advantage is that it gives you the flexibility to adjust how much money you get depending on how your business is doing.
- As a disadvantage, your taxes aren’t automatically deducted with this method, so you’ll have to self-report the draws you made and pay taxes on them.
Step 6 – Choose Payment Frequency
The only thing left now is to choose how often you pay yourself. Some of us believe in the monthly payment, others like to be paid biweekly (every other week), semi-monthly (twice a month) or weekly. There’s no good recipe for payment frequency, the right pick mostly depends on the type of your business and your personal needs.
Don’t forget that the more frequent you pay yourself, the more administrative tasks you’ll have: recording the transactions you make between accounts and following up with client payments more often.
All in all, how much you pay yourself depends largely on how successful your business is. As we have said, if you are at the beginning of your career, do not expect a big leap in the first year, but try to achieve slow and steady growth instead.
In the meantime, pay yourself as much as you need, but not unrealistic amounts. Once your business is truly profitable, there is no reason not to reward yourself properly for the success you have achieved.