When to Take a Salary as a Small Business Owner
Have you begun to take a salary from your business yet?
For many entrepreneurs, it takes a few years before they feel comfortable taking money out of the business. At first, there are no profits to draw from. Then, they want to reinvest every penny. But finally, they realise they have no choice but to pay themselves.
This path is a common one… but is it advisable?
That’s exactly what I’m going to explore in this post.
When to start taking a salary from your business.
If you happen to be in a position where you don’t actually need a salary from your business, you have a choice. You can postpone paying yourself until your business makes a profit.
But most experts agree that the correct time to start is ‘as soon as you’re in the black’. When you start paying yourself immediately, you’ll gain a true picture of your business’ profits and losses.
Also, many investors will want to see that you are drawing a salary, so they too can get a true feel for the business’ profitability. But naturally, the amount you withdraw will also be under scrutiny. Investors will see all kinds of red flags if you’re withdrawing 90 per cent of the business’s profits as salary.
There should be a balance.
Should you take a salary or draw funds?
In the start-up phase, many business owners will ‘draw’ from their business instead of taking a set wage. This makes sense when profits are low, and you need just enough to sustain yourself.
If you decide to draw funds within the first year instead of paying yourself a salary, you can take from the business at irregular intervals – just keep track of what you’re taking. Avoid using business debit cards for personal use. This will only confuse your bookkeeping and make tax time very difficult (an actual nightmare if you get audited).
When you pay yourself out of your business, it’s a regular expense. You can raise or lower your salary as profits increase or decrease, but it should remain as steady as possible. It’s similar to a salary you would receive from an employer, but the tax filing is different – so if you have any questions about this part, talk to an accounting professional. Decide on what you need (take home pay) and then use a pay calculator to determine the amount you need to pay (including taxes).
Whether drawing or taking a salary, there are some tips you should follow.
Five Tips for paying yourself from your start-up.
1. Use a good accounting program
Even if you’re the only one drawing a salary, it’s important to keep track of your business finances in a good accounting program (Think Xero, Quickbooks, etc.). The right program will help you get a great picture of your actual profits, and you can’t determine your salary without a true picture of your net position.
2. Consider your true value.
Your salary should be a good balance between your true market value and what your business can afford to pay. So, before you come to a number, consider your own value. Think about the following:
- What would another business pay you for the same service?
- Is your salary reasonable based on the hours you’re working?
- If you have employees, how does your salary compare to theirs?
3. Consider your business type.
If you’re operating as a sole trader, it’s up to you when you decide to take a salary. If you’re running a partnership or PTY, you’ll need to receive wages regularly like an employee. In this case, you’d be responsible for your partners or shareholders, so you must show consistency.
4. Think about forming a business agreement.
If you don’t need a salary to sustain you during the start-up phase, think about forming a business agreement. This is a bit like a loan from you to the business. Your salary will become a liability to the business, but it allows you to defer payment until a date when the business is (hopefully) profitable.
5. Base your salary on profits.
It’s true that you should first consider a true market value for your services, but as the owner, your salary should be somewhat tied to the business’s profits. Most small business owners limit themselves to 50 per cent or less of the business’s profits (not turnover!).
This leaves funds to reinvest into growing the business, so everyone has the potential to earn more in the months and years to come.
If you’re operating as a sole trader, the decision to take a salary can be very personal. On the other hand, if you’re running an incorporated company with other stakeholders, you may need to take a salary from the start.
Either way, it’s a balancing act to make sure you earn a reasonable salary without depleting the precious reserves of your business.
If you have any questions about what’s right to do for your business, talk to your accounting professional.
“The opinions expressed by Smallville Contributors are their own, not those of www.smallville.com.au"
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