If you have been able to start and keep a business running month in, month out, year in, year out, despite facing challenges, that’s no ordinary feat you’ve achieved.
In the process of growing your business and keeping it running, you would have been caught up in the web of complex operations like managing your clients, handling business operations, and trying to grow your brand, forgetting that there’s an important aspect of your business: paying yourself.
As a small business owner just starting out, you might get confused about how and when to start earning income from your business for personal use.
You need to ask yourself, “Should I pay myself a salary or take a draw? If I am paying myself a salary or making a draw, how much would I pay myself or withdraw? How do I handle taxes?”
Unlike your traditional 9–5 where your paycheck arrives as at when due, paying yourself as a small business owner requires that you make deliberate effort to get it right because it will not only impact your personal finance but will also affect your business health in the long run.
Therefore, in this article, you will learn how to pay yourself properly based on your business type, income, and financial goals.
1. Understand Your Business Structure
The first step to paying yourself from your small business is to understand your business structure, i.e., know the type of entity your business is. Common business entity types include:
- Sole Proprietorship or Single-Membership LLC
If you’re not running your business in partnership, then you’re running a sole proprietorship or LLC kind of business.
Your pay does not come as salary, the money you make from running your business is your income. Therefore, what you get is ‘owner’s draw.’
However, you can only make an ‘owner’s draw’ after setting aside money for taxes and business expenses by transferring from your business account to your personal account.
- Partnership
If you’re in a partnership with your spouse, friends, or other people with similar business interests, then your business assumes a partnership entity where the owners get paid based on agreed percentage as outlined in your partnership agreement.
Also, like sole proprietorship or LLC kind of business, you make owners’ draw after deducting tax and recurring expenses from the total revenue.
- S Corporation
A business structured as an S Corporation, makes the owner an employee, so you are expected to pay yourself a salary that should correspond with what you would earn in a similar position working for another organization.
The advantage here is that that your tax is charged as personal income tax.
- C Corporation
If you’re a C-Corp business owner, you’re considered an employee of your business; hence, you’re on the company’s payroll.
However, C-Corp suffers double taxation—paying corporate income tax and personal income tax after dividend payout.
Read Also: 6 Habits You Can Learn from Successful Savers
2. Determine a Reasonable Pay for Yourself
How much should you earn from your business? Determining how much you should earn from your business, whether as salary or owner’s draw, depends on the financial health of your business.
Pay yourself only from what is left after you have sorted out taxes, recurring expenses, and emergency fund to ensure that your business becomes sustainable.
A simple rule for making an owner’s draw is to pay yourself a fixed percentage of your business’ net profit so that your pay adjusts according to your business growth and performance.
Alternatively, factoring in your role as an entrepreneur and business manager, documenting the number of hours you put in can help you decide how much to earn from your business as salary or owner’s draw.
Averagely, you can earn between $60,000 to $70,000 dollars yearly as an entrepreneur.
Before deciding how much you can earn from your business, you should consider the following:
- Business stage
If your business is in its infancy stage, you may not be able to pay yourself from the business because you’re in the nurturing stage, trying to build a self-sustaining business.
However, once your business is on a firm footing with a good cash flow, then you can factor in your salary/owner’s draw into the business’ operating expenses without negatively impacting the growth of your business.
- Personal Finances
The amount you pay yourself and how you pay yourself determines a lot.
The income you earn from your business should cover your personal expenses like mortgage, loan repayment, emergency funds, personal/family upkeep, and other basic expenses without negatively affecting your business.
Read Also: How to Save For Different Financial Goals & Benefits of Planning Your Finances
3. Set up A Business Budget
As a small business owner, it is imperative that you set up a business budget that clearly separates personal finance from business finance to clearly track your business cash flow.
Much like rent and utilities, ‘owner’s compensation’ should also fall on the essential side of your budget list as a fixed business expense for a regular and sustainable pay.
Having a business budget for your business is essential for maintaining the financial health of your business, clarity of vision, simplifying tax filings, and ensuring legal protection.
It also ensures that you get paid consistently from your business.
Read Also: 9 Practical Budgeting Tips for Easy Money Management
4. Make Plans for Tax Payment
While planning your paycheck, you should also make plans for your taxes.
As an entrepreneur, you’re responsible for taxes like income tax, self-employment tax, and payroll taxes depending on the type of business entity you’re operating.
However, a smart way of handling tax-related issues is to set up 15–30% of your business’ net income for tax payment.
This will save your business from facing complicated tax issues or even falling behind on IRS obligations.
Additionally, consulting a tax expert ensures compliance with tax laws and also protects your business and income from myriads of tax complications that can put your business and income at risk.
Read Also: 9 Practical Budgeting Tips for Easy Money Management
5. Reinvest
Your business needs to grow, and that can only happen by reinvesting a part of the profit from your business.
When your business is not doing well enough, then you have to cut down on your personal income from your business to support the growth and sustainability of your business.
When your business becomes stable, churning out profit consistently, reinvesting part of the profit from your business into marketing, inventory, equipment, or hiring more hands can generate more income for you in the long run.
However, the trick to business growth and sustainability is to strike a balance between your personal finance and business growth.
Example: in periods where you’re experiencing low revenue, you should cut down on your pay to keep the business going.
In high-profit months, you can give yourself a pay raise while also reinvesting a larger chunk of the profit from your business.
Read Also: Grow Your Money Faster: 9 Easy Investment Tips
Conclusion
As a small business owner, it is important that you have it in mind that you’re not starting a business for the purpose of immediate financial gratification, but for setting up a sustainable system that ensures your financial well-being and your business’s growth and sustainability.
Therefore, you may not pay yourself when you’re just starting out in business.
However, it is important to have a business projection that factors in your salary or owner’s draw.
Also, it is important that you keep your personal account separate from your business account, never spending from your business account for personal purposes.
