There is nothing more stressful than putting up capital, running a business, and not getting a penny in return. Sounds crazy right? It is actually a more common practice amongst entrepreneurs than you would think. How much should you pay yourself anyway?
There is a tendency to believe that you should either
- not take any money from the business until it is profitable OR
- use your business credit card to go on a spending craze
Neither of these two approaches is the right way to manage your finances. And I can tell you from experience that neither will get you closer to your financial goals.
How much you should pay yourself, is especially important if you have quit your full-time job to fully focus on your business. The truth is, your business might take months, if not years, to break-even. You would not want to go through sleepless nights of hard work, only to have to send around the offering plate for people to help you pay your bills.
Here is what you should do, because you deserve to pay yourself:
1. How much is your business left with after paying non-negotiable expenses?
This will give you a realistic view of how much you could be paying yourself.
However, remember that non-negotiable expenses include taxes, which are usually paid at the end of the year. So remember to make an allowance for these expenses when calculating how much your business can afford to pay you.
2. There is a difference between a salary and a dividend
This is rather obvious, but I believe that it is the reason why a lot of us in business wait until their business is profitable, before paying themselves.
A salary is what you pay yourself to reflect the value that you bring to the business every day. A dividend is what you pay yourself as a shareholder for investing your funds into the business. A dividend is usually paid out when the business has made profits (income made is higher than the money spent on expenses).
Whether your business is making money or not, I believe that you are adding value and putting your time and effort into growing your business. Just like any other person that you would employ, you deserve to be paid.
Leave the dividends until when your business is profitable, but in the meanwhile pay yourself a reasonable salary.
So the question remains: How much should you pay yourself?
3. How to determine your salary
There is obviously a limit to how much you should pay yourself. Because the income that you make from your business will first need to cover
- all non-negotiable expenses
- taxes (if your business is profitable)
You can determine how much to pay yourself by using your basic worth as a starting point:
- How much do you believe is your basic worth? You can use the last salary you earned from employment or the salary of people in your area of expertise as a starting point
- Add inflation so that your income is protected from an increase in the cost of living for at least one year.
So for example, if your previous employment salary was $30,000 per year, then you can use the same salary amount and add inflation of 6% to determine the salary to pay yourself -> 30,000*1.06 = 31,800. Divide this amount by 12 to get your monthly salary -> 31,800/12 = $2,650.
It is important to make sure that you have enough funds to put back into the business for growth and any unexpected eventualities after paying your salary.
As a rule of thumb, try and keep your salary within 20-30% of the money you earn from the business.
Personal expense-based approach
Start by determining your monthly expenses, that your salary needs to cover. Also factor in your annual and quarterly expenses into this monthly cost.
In the early phases of your business, it is important to be as prudent as possible with the funds that you have, so try and cut down on your discretionary personal expenses.
Once you have determined your total monthly expenses, you can use this figure as your salary, as long as it is not an extremely high percentage of your expected income (between 20 and 30%).
4. Allowing for your salary in your business budget
As part of running your business, you need to have a budget at least 12 months ahead of time, so that you are always in the know of how much income you need to make in sales in order to cover your costs (create a budget). Make sure that your salary is included in these costs so that even if you need to raise capital or take a loan, your salary is already factored in.
Download this profit tracker to start tracking your income and expenses, including your salary expense.