The early days of owning a business are exciting.
You’re following your dreams and likely excited about all the potential money to be made.
But money can be sparse when you’re just getting off the ground, so it’s important you determine the correct amount to pay yourself. Too much and you’re putting the business at risk. Too little and you’re putting yourself at risk.
Here are some tips for striking the right balance when deciding how much to pay yourself.
Pay yourself out of profits
When the money starts flowing in, many new business owners get overly excited. However, it’s important that you don’t lose sight of all the costs that come with running a business. Bills, taxes, payroll and other expenses should be taken care of before you take your cut.
The money left over is your business’s profit. These funds are where your compensation should come from.
But also reinvest in your business
Don’t fall into the trap of thinking all the profit is your take-home pay. If you have ambitions to grow your business, you’ll need to reinvest a portion of the money you’re making.
It’s also important to remember that you’ll owe income tax on the funds you pay yourself. But money spent on your business can often be offset against taxes. So the case can be made that it’s more valuable to keep profit in your business — especially since you’ll probably be able to give yourself a raise as the company scales up.
Pay yourself like it’s any other job
A good approach is to pay yourself just like a regular job would. Decide on a reasonable salary figure and pay yourself equal portions on a regular basis.
Paying yourself a regular salary looks normal to the IRS and other tax agencies. Inconsistent chunks of money moving from your business to personal bank account at random times might get their attention though.
So how do you decide on a reasonable salary? Here are some questions you can ask yourself to help:
- What are your skills and experience worth in the general job market?
- What’s the average cost of living in your area?
- Is your salary fair for the duties you’re performing and the time you’re committing?
Above all else, you should pay yourself enough to live on. You might need to be frugal when your business is young, but you should maintain a reasonable standard of living.
The rare instances you should not pay yourself
It’s generally never a good idea to go without paying yourself for extended periods of time. However, if your business hits a rough patch, it can be beneficial to skip just the one pay period or even reduce your salary.
A good time to reconsider your compensation is after layoffs or benefit reductions. Employee morale is normally low when these situations happen and it can look bad if you’re not making sacrifices too.
Another time you should think about reducing your compensation is when you’re struggling with debt. Your lenders will likely be less inclined to give you a break if they see you’re still taking home a big check.
The amount you can pay yourself ultimately depends on your business’s level of success. The more money the business makes, the more you as the business owner can take home. While you should always be careful to not overpay yourself, you certainly reap the rewards of your success.
About the author: Dave Anderson is an Outreach Writer for Xero accounting software. He lives in San Francisco and enjoys writing about technology, entrepreneurship, marketing, and a variety of other topics.
If you’re interesting in learning more, check out Xero’s guide on how much to pay yourself.