In part, many people start their business to follow a passion. The other main reason people choose to follow an entrepreneurial dream, is to make money.
A stumbling block that often comes up, is how much to pay yourself.
Your salary will be dependent on the legal setup of your business and what stage you are in your business. Which structure is best for your business, how much you should pay yourself and the implications on tax should be discussed with your accountant.
If your business is still in startup phase, you might not have very much (if anything) left over after your operating costs (the costs incurred to run your business). Being frugal and living off savings to kick start your business is common during this phase, but not something you want to be doing long term. To live your business dream, your business needs to make money!
A huge milestone in your business, is when it starts to generate a regular profit.
It is very exciting when money starts coming in, but don’t get over zealous and start spending everything that comes in. Remember you need pay yourself out of your business profits, not your business revenue.
Strike a balance between paying yourself and reinvesting for business growth
Before we go any further, let’s look at the difference between revenue and profit. Not all the money your business makes is yours to spend. Revenue is the money your business earns from the sales of your goods and/or services. However, you need to pay for you operating costs / business expenses first, this comes out of your revenue. What is left over is your profit.
Revenue – Expenses = Profit
Your profit is yours to spend.
Now let’s continue … How much money you need to make in the early stages of your business really is dependent on your personal living expenses.
5 steps to work out how much to pay yourself
Step 1: Calculate your personal living expenses
How much money do you need to support your lifestyle?
Working out your personal costs will help you determine the salary you will need from your business.
The first thing you to do is put together a list of ALL your expenses (look at all you weekly, monthly, quarterly and annual expenses). At this stage just list everything, once you’re done you might want to have a review of your personal expenses to see where you can reduce anything.
Your total living expenses will be your minimum salary.
Step 2: Determine your cash flow forecast
Once you’ve worked out the minimum salary that is needed cover you living expenses, you’ll need to ensure your business will generate enough money to cover its operating expenses as well as your salary. To do this, calculate your cash flow forecast.
Ideally, your business will have enough cash coming into to cover operating costs and your salary. If not, you may need to consider working part-time (or even full-time) to cover the shortfall until your business can generate enough money to cover both.
Step 3: Pay yourself regularly
When your business is profitable enough and you can afford to pay yourself, rather than taking out the profits as they come in for personal spending, pay yourself a regular amount instead. Use the minimum salary calculated above as a starting point, if your business can afford to, then certainly pay yourself more.
You might like to pay yourself weekly because you may find it easier to manage your money this way, but perhaps you prefer a fortnightly or monthly salary. Whatever you decide, make sure you budget your salary.
Think of your salary like a business expenses and include it in your business forecast. This ensures you’re not overspending and you have enough money aside to cover your business and personal expenses. You can review your financial position monthly/quarterly and if your business does better than expected you can always give yourself a bonus! Likewise, if your business is going through a rough patch you might need to drop your salary somewhat to keep your business in operation.
Step 4: Put money aside for tax
Don’t get caught about by your tax obligations.
The best way to keep on top of your tax obligations is by putting a regular amount aside into a separate bank account, that you do NOT use. I know it can take a lot of discipline to not touch the money, but it means you will have the money available when tax is due.
Work with your accountant to help you estimate how much tax you will need to pay at the end of the financial year.
Decide whether you prefer to put aside money for tax on a weekly or monthly basis. Divide your annual tax estimate by 52 or 12 (to work out the weekly or monthly amount) that needs to deposited into your bank account specifically for tax.
Step 5: Review your salary
When your business is consistently making a good profit, it’s not only super exciting but time to re-evaluate your salary.
You have two options here.
- give yourself a raise
- keep the lower salary and reinvest the extra money back into the business in order to grow your business.
The more money you take as a salary they more tax you will need to pay, so it could make more sense to invest your money back into the business for business growth. Again, this is a matter that should be discussed with your accountant.
There is a lot to factor in when determining your own salary from your business, but the important thing is to balance investing money to create and grow your business while having enough money to live on.