Small Business & Startups

How Much is Appropriate to Pay Yourself?

Finance : How much is appropriate to pay yourself?The early days of owning a business are exciting. You’re following your dreams and likely are excited about all the potential money to be made. There’re a ton of reasons entrepreneurs go into business for themselves but making more money is inevitably a main driver. However, if you’re not one of the lucky ones who happens to be in the right place, at the right time, with the right pitch, it can take time to build a thriving business. So until that money starts coming in, you might be wondering how much is appropriate to pay yourself. According to Quickbooks, you “generally have two options for taking home a paycheck: a salary and/or a draw based on the structure of your business.” Check out these tips to help you decide the best avenue for you:

Pay Yourself With Profits

It’s generally a good idea to take care of all the expenses before you take any money out of the business. Good accounting software can provide a clear picture of the various overhead costs that are coming out of your revenue. The leftover funds are your profits, which is where you can pull your salary from.

Consider Reinvesting Profits

However, don’t take all the profits for yourself if you aspire to grow your business. You’ll need to reinvest in resources that can aid in growth and lead to greater profits in the future. Money removed from your business will likely be taxed at a greater rate than reinvested money. The case can certainly be made that leaving profits in your business will have a greater long-term benefit.

Pay Yourself Reasonably

So what’s a fair slice to take out for yourself? It depends on your circumstances but in general, stick to a reasonable amount you can live on, on a consistent basis. Take into account the basics like the average cost-of-living in your area, what comparable positions pay at other companies and the value of your duties.

You’ll also want to consider how much cashflow and profitability your business can generate.  If you’re don’t have partners, then you’ll have a great deal of discretion on how to pay yourself.  On the other hand, if you have outside investors or lenders, you’ll often need to get your compensation approved by the Board of Directors.  We often recommend setting very modest fixed compensation amounts or salary and give yourself an extra bonus if your business has a booming month.

Once you have a salary determined, pay yourself a fixed amount on a regular basis. It looks far more normal to a tax agency than sporadic chunks of money leaving your business account at irregular times.

Cut Paychecks on a Regular Schedule

Should you pay yourself monthly or quarterly? There really isn’t a clear rule of thumb for this one. Keep in mind though, if you pay yourself less frequently, you’ll incur fewer payroll costs.  Most business owners either pay themselves once or twice a month.  However often you choose to pay yourself, just stick to a consistent schedule.

Should I Ever Not Pay Myself?

While you should never sacrifice your livelihood for the benefit of your business, you might want to consider taking home less or skipping a pay period when the business is struggling. Remember that part of being a business owner means enduring scrutiny. Employees, investors and creditors will likely be upset if you are taking home a big check while the business suffers.

If you own all or most of the company though, you really should skip paying yourself when the business is hurting — you’ll just end up with a bigger bill at the end.  Using a line of credit to pay your payroll, isn’t a problem if it’s serving to mitigate short-term working capital needs.  But using longer-term debt to pay yourself, maybe an indication that your compensation level is too high compared to profits of the business. Consider adjusting it until profits go back to a higher level.

  • Pro Tip: If you’re a cash basis taxpayer, it usually makes sense to pay your final payroll or any owed bonuses by December 31st.  This will allow you to defer some of your tax payments to the following year.

Investors Relations Change Your Paycheck

In almost all cases your investors will be interested in your compensation (they might even require that they approve it too).  This is a very reasonable request on their part as investors are also owners in the business and often have rights to determine how the cash they put into the business is being used.

Paychecks with Partnerships

It’s a requirement for partners to be in agreement on their compensation structures.  When it’s not clear on who’s getting paid what and how often they’ll get paid, it almost always lead to conflict between the owners. Do yourself and your partner a favor and make sure your compensation agreements are transparent from the get go.

 

In the end, your compensation depends on the success of the business you run. You don’t want to overpay yourself but – if your business is successful – you do deserve to be rewarded. Check out the Xero Small Business Guide “How Much to Pay Yourself”  to learn more.

 

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