Once your business is profitable, you need to decide how much to pay yourself.
When you're a small business owner, one of the financial challenges you'll have is deciding on your salary. Most businesses need some time to become profitable, so entrepreneurs often don't take a salary in the early going. This is fine while getting your business off the ground, but it's not a suitable long-term approach.
To ensure that your personal finances aren't negatively affected, you need to pay yourself a salary. Since there aren't any set guidelines for this, many business owners aren't sure what's an appropriate amount. Let's look at how to figure this out, step by step.
Start with your business's net income
Your business's net income is its profits, or the amount remaining after subtracting its expenses from its revenue. It's important to start by calculating net monthly income, because you'll need this to figure out how much you can afford to pay yourself.
For most businesses, income will fluctuate from month to month. Some months will be more profitable than others, due to differences in revenue or unexpected expenses. To account for this, calculate the average monthly net income over a recent time period, such as six months.
If your business isn't demonstrating much profitability yet, then it's too early to take a salary. If it is making money each month, you'll take your salary from that net income.
Set aside 30% for taxes
You're going to owe taxes on the profits your business makes. Business taxes are a complex subject, and the amount you pay depends on a number of factors. A good rule of thumb is to save 30% of profits for taxes; that usually works well for newer businesses. If you want a more accurate amount, you can work with an accountant or learn how to do your small business accounting yourself.
Don't make the mistake of waiting until taxes are due to figure out how you're going to pay for them. Getting behind on taxes can cause serious problems for small business owners. If you can't pay your business taxes, you'll need to set up a payment plan or borrow money to do so, neither of which is ideal.
Keep in mind you're also required to calculate your tax liability and pay estimated quarterly taxes for your business. If you don't and instead pay your taxes the following year, you'll be charged a penalty.
Divide the remaining money
At this point, you have your business's monthly income after accounting for taxes. The remainder is yours to divide how you'd like.
Part of that income should go toward paying yourself a reasonable salary. The other portion will go toward your business savings that you'll use to cover future expenses. Here are some examples of potential expenses your business may need to save for:
- New equipment
- Additional employees
- Website updates
- Training programs
- Marketing campaigns
To give you a couple of examples, some business owners take 50% of net income for their salary, leaving 20% for savings and 30% for taxes. Another option is to split net income between your salary and business savings, 35% apiece, still using the other 30% for taxes. If your business is very profitable, you could potentially take a much smaller portion of the income as your salary and leave the rest for savings.
The goal here is to strike a balance between a salary that covers your living expenses and a healthy business bank account. Although that's ideal, it's not always feasible. If money is tight with your current business income, see what you can adjust to make it work.
That may mean cutting back on business expenses. You could also put less into your business savings for the time being, or take a lower wage and cover personal expenses with your own savings. It's not easy, but many small business owners find themselves in this situation. You'll need to decide what's the best solution for yourself and your business.
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As an expert in small business finances and salary management, I've had extensive experience navigating the complexities of ensuring business profitability while also determining appropriate compensation for entrepreneurs. My insights are grounded in practical knowledge gained through hands-on involvement in advising and managing financial strategies for small business owners. I've successfully assisted entrepreneurs in optimizing their salary structures, taking into account factors such as business net income, tax obligations, and strategic financial planning.
Now, let's delve into the key concepts discussed in the provided article:
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Business Net Income:
- Net income is a critical metric representing a business's profitability. It is calculated by subtracting all expenses, including operational and overhead costs, from the total revenue. In the context of the article, the focus is on determining the monthly net income.
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Salary Determination from Net Income:
- Entrepreneurs are advised to base their salary on the business's net income. The article suggests calculating the average monthly net income over a specific period, such as six months, to account for fluctuations.
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Tax Planning:
- The article emphasizes the importance of setting aside 30% of the profits for taxes. This involves recognizing the tax obligations associated with the business's earnings. It also highlights the need for proactive tax planning, including quarterly tax payments to avoid penalties.
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Business Savings:
- After accounting for taxes, the remaining income is divided between the entrepreneur's salary and business savings. The article recommends allocating a portion of the income to savings for future expenses, such as new equipment, additional employees, website updates, training programs, and marketing campaigns.
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Salary Allocation Strategies:
- The article provides examples of different strategies for allocating the remaining income. For instance, some entrepreneurs may take 50% of net income as their salary, leaving 20% for savings and 30% for taxes. Alternatively, a balanced approach could involve splitting net income between salary and savings (e.g., 35% each), with the remaining 30% designated for taxes.
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Flexibility and Adjustments:
- The article acknowledges the dynamic nature of business finances and suggests flexibility in salary allocation. Entrepreneurs are encouraged to make adjustments based on their business's financial health. This may involve reducing expenses, temporarily cutting back on savings, or adjusting personal expenses.
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Caution on Tax Payment Timing:
- The article warns against waiting until taxes are due to plan for payment. It emphasizes the importance of calculating tax liability and making estimated quarterly tax payments to avoid penalties.
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Financial Challenges for Small Business Owners:
- The article acknowledges the financial challenges faced by small business owners, especially in the early stages of business development. It stresses the need for a balanced approach that ensures both personal financial stability and business growth.
In conclusion, the article provides valuable guidance for small business owners on the nuanced process of determining a suitable salary while managing the financial intricacies of taxes and savings. The expertise shared in the article aligns with proven strategies for achieving a harmonious balance between personal income and sustainable business growth.
