You start a business with the hope of primarily making a living from the business. Whether you want to earn just enough money to cover your living expenses or money that will allow you to live a jet setting lifestyle, the business needs to earn money for you.
But are you making money from your business?
The issue of drawing a salary from the business draws a wide variety of responses from small business owners, particularly home-based entrepreneurs and sole proprietors. Even here at PowerHomeBiz.com, the question of whether we should pay ourselves a salary when we started was a hotly debated topic.
When asked if they are getting paid by their businesses, there are those who:
- Don’t get paid anything as all money is being plowed back into the business.
- Pay themselves the prevailing market wage based on industry salaries.
- Pay themselves a percentage above their highest-paid employee.
- Pay themselves a percentage of the profit.
- Pay themselves whatever is left of the profits after all the bills have been paid.
- If the business has debts and the goal is to pay down the loan fast, the entrepreneur is willing to accept a smaller pay.
- Pay themselves amounts based on how much they can live on, pay their own bills and still put money back to the business.
- Consider the business to be their personal bank account and take out the full profit as their salaries.
According to experts, the most commonly used practice of small business owners in determining their salary is the “leftover approach.” Since their salary is based on whatever is left after all the bills have been paid, they don’t really have a fixed salary. As a result, they don’t really know how much they will receive as a salary from the business.
They contend that this is a state of mind problem for small business entrepreneurs. It is indicative of the entrepreneurs’ lack of business and financial know how. They don’t know what they are worth and their contributions to the business, and afraid to make the statement that this is how much they are worth.
As a result, they fail to incorporate their salary into the pricing of their products or services. Some experts even take it a step further to say that the reason many small business entrepreneurs fail in the first two years of business is because they don’t understand the financial aspects of the business in general and their cost structure in particular.
Then, of course, there’s the question of when the entrepreneur should draw a salary. Should the business owner get paid as soon as the business starts, or only when the business starts to breakeven and earn a profit? Should the business owner wait at least two years before drawing any salary? Or can the business owner receive a small salary initially, then take out a bigger pay when the business grows?
If you’re in the same boat and thinking of how you are going to pay yourself a salary, here are some factors to consider:
- Decide that you should be paid a salary. The first step is convincing yourself that you need – and deserve – to get paid for your work in the business. Have the confidence and conviction to say that this is what your value is to the business. Then decide whether the business needs to pay you now, or if you are willing to defer the payment of the salary. Remember, you should consider your situation now, as well as the life you want to lead down the road when you retire.
- Understand the value of your time. Figure out how much your time is worth. Determine the quantifiable dollar value of your time. When you see the actual amount of how much your time is worth, it is easier to calculate a salary for you. This will compel you to include your salary in your pricing.
- Consider your overall business situation. You can’t pay yourself money that you do not have. Look at the profitability of your business – not just gross sales. Determine the level of profits in the past few months (or past few years). What, if any, can the business afford at this point to pay you as your salary? You don’t want to set yourself in a situation where you are getting a good salary, but not supporting the business.
- Determine your goals for your business. What is important to you? You may feel strongly about getting paid and receiving a salary for all your contributions to the business. Or you may be ok with receiving a much smaller amount compared to the market levels in order to put more money into the business and ensure its long-term growth and profitability.
The key is to find the right balance. You don’t want to take all the profits of your business because you need to put back some money to support its growth. Yet you also don’t want to put all the profits back into the business that you can’t even enjoy the fruits of your labor. Take everything into consideration — your own goals, your family, your retirement goals — and make a decision how much and when should you start drawing on your salary.