As a business owner, part of your motivation for starting a new business is most likely to make a salary that provides you with the lifestyle you desire. While the average CEO in the United States now makes approximately 361 times more than the average employee at the same company, this is number is skewed by large businesses. SMB owners are much more likely to take a moderate income, or, in a surprisingly high number of cases, no income at all.
But it’s not easy to determine what you should pay yourself. A new business often benefits from reinvesting as much of its revenue as possible, meaning the owner will take less as a salary. So how much should small business owners make? And how can you find the right business owner salary as a percentage of the total revenue? Let’s take a look at a handful of tips and strategies to use when managing your payroll.
According to Fundera, over 30% of business owners take no salary at all. And the vast majority make less than $100,000. It’s important to remember that starting the business is the easy part. Creating a profitable operation is what is particularly difficult. An incredible exceptional few quit their job, start a new company, and start raking in a healthy salary right away. For most business owners, it’s a long, uphill battle with plenty of obstacles along the way.
Likewise, despite its 2010s trendiness, venture capital money is not easy to come by. Again, very few new companies receive any substantial financial help other than traditional small business loans. In these cases, many SMB owners will take $0 in salary so that the business can stay afloat for the first years. These funds can, among other things, be used to help pay off debt, go in emergency funds, invest in new products or infrastructure, or go towards payroll. While the amount of time to reach profitability greatly varies, the rule of thumb for most businesses is about three years.
While you may dream of making boatloads of cash down the road, it’s important to go into starting a business with some financial perspective. Plan for several years of smaller or no salary. To be fair, that’s a lot easier said than done. But there are a few ways to make it easier. Here are a few:
1. Get an Emergency Fund Set Up
This needs to be done before you quit your day job. Starting a business is plenty stressful in many ways, so having some more slack with your bank account will allow you more flexibility and a lot more time to start turning a profit. By most accounts, a smart emergency fund should be cash worth approximately a year’s worth of expenses. Some estimates say 3-4 months, while others say 2 years, but the year seems to be the average. If you don’t have this yet, start saving now!
2. Cut Down as Many Expenses as Possible
While you want to make sure that your business gets up and running with the best equipment and facilities as possible, you also need to spend according to your budget. Shave off non-essential expenditures wherever you can, like office supplies, heating/cooling, and subscription services. Do the same with your personal budget. Cut down on your day-to-day costs, like eating and drinking out, insurance coverages, transportation expenses, and other basics. If you have any extravagences, get rid of them entirely.
3. Get a Second, Part-Time Job
A casual, low-stress job on the side might be a nice break from the grind of your own business. It allows you to meet new people, learn new skills, and bring in a little extra cash to help you get by during the nascency of your business. Today, there are more and more jobs that can be done remotely, giving you more flexibility with hours and location. Other new services, like Lyft and Airbnb also give you more options for additional income without taking up too much of your time.
4. Get a Business Partner
If you’ve started the business on your own and want to try to survive without an income for awhile, having a partner can make a huge difference. Another person involved will allow you more time to get a second job, and will take a lot of stress away from the endeavor. They will also provide a different set of strengths, making the business more likely to succeed.
5. Figure Out What Loans Make Sense
There are many possible revenue streams for starting a new business. Some new businesses start by looking for venture capital start-up money. Others go through banks for traditional business loans. But SMBs have more options now than ever with Government SBA loans, business credit cards, and peer-to-peer lenders. New companies can also ask personal connections for smaller, more casual loans. Whichever route you go, just be sure that you stay away from high interest and feel confident that you’ll be able to pay off your debts in a timely manner. Securing this sort of financing helps small business owners survive the first few years of operation.
There’s really no one-size fits all method for determining the right salary. Simply adhering to a strict percentage-based pay without factoring in other business details can be dangerous. Instead, make sure you’re accounting for various aspects of your business operation.
- Figure out your annual net income for your business. Your net income is the profit left after all business expenses are subtracted. This is the most basic step that needs to be taken towards determining your salary.
- Anticipate taxes that will be owed at the end of the year. Too often, small businesses forget about taxes that will be owed at year’s end. Unfortunately, the IRS isn’t too friendly about negotiating these so it’s best to err on the side of caution. 30% of your total income is a safe spot to assume. Discuss these plans with a trusted business accountant.
- Take all debts into account. Subtract all monthly debt payments that are set up. It’s advantageous to pay off debts sooner rather than later (if the loan structure allows you to). Plus, interest paid on business loans is tax deductible.
Think about the future of your business. Growing a business is expensive, so plan your funds accordingly. Are you planning any of the following:
- Expansion to new locations
- New positions
- Equipment upgrades
- Increased inventory
- Marketing improvements
- Take inventory of your personal expenses. Analyze what your fixed expenses (heating and water) are versus variable costs (groceries and transportation) and luxuries (dining out and traveling). What can you cut back? How do you want to prioritize extra costs?
- After taking the strict costs like taxes and business expenses out of the equation, prioritize the rest of your potential costs to determine how much you pay yourself. Once you cover enough to keep your business open, the rest is somewhat flexible. It’s always best to invest more into your business, but not always necessary.
Once you have all finances sorted out and a clear differentiation between your business and personal expenses, you need to figure out how you’ll get the money into your personal account.
First, consider the type of business that you have. The IRS has different regulations surrounding owner salary for LLCs, partnerships, corporations, and sole proprietorships.
Salary Pay – This is the same type of pay that your full-time employees will get. You receive a paycheck of a set amount on a regular schedule. It can be based on total hours worked or at a flat rate. If you’re the owner or even an officer of a C-corporation or S-corporation, you’re actually required by law to pay yourself a salary.
Draw Pay – This method of payment is common for less established small businesses. Owners can withdraw money from the business’s profit once all business costs are accounted for and distributed. Income draw do not require that any amount is withheld for Social Security or Medicare, but they are, of course, subject to income taxes. So be sure to have money set aside to pay taxes on your draw at the end of the year.
No matter the route you go, make sure that you’re adequately rewarding yourself for all of the hard work that goes into running a business. For assistance with business operations, check out KORONA POS. Your point of sale should be at the heart of your entire business. Easy metrics and reports make understanding profitability and optimal salaries much more easy. Click below to learn more, and if you like what you see, sign up for a free trial with the software.