In part, many people start their small business to follow a passion. The other main reason people choose toto start a small business, is to make money.
A stumbling block that often comes up, is how much to pay yourself.
How you pay yourself 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 small 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 small business needs to make money!
A huge milestone in your small 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 small 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 small business really is dependent on your personal living expenses.
4 steps to work out how much to pay yourself as a small business owner:
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 small 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 money that is needed cover you living expenses, you’ll need to ensure your small 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 small 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 small 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 for your pay.
Your pay is a small business expenses and needs to be include in your business forecast. This ensures you’re not overspending and you have enough money aside to cover your small business and personal expenses. You can review your financial position monthly or quarterly and if your small business does better than expected you can always give yourself a bonus! Likewise, if your small business is going through a rough patch you might need to reduce the amount you pay yourself somewhat to keep your business in operation.
Step 4: Review how much you pay yourself
When your small business is consistently making a good profit, it’s not only super exciting but time to re-evaluate how much you pay yourself.
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 small business
There is a lot to factor in when determining how much you will pay yourself from your small business, but the important thing is to balance investing money to create and grow your business while having enough money to live on.