How Much Should a Business Owner Pay Themselves?
Since a business owner does not typically receive a steady paycheck, they must strategically map out their budget for the year with their expected income or capital funding and subtract the various expenses they will incur to see how much money is left for their salary. The yearly income of business owners is truly up to them. Nonetheless, the amount of money that gets invested in the business, saved for taxes, and placed into their personal bank account must be carefully considered to avoid a failing business.
This article will go into depth about how to budget your net income into a salary without going broke. This type of budget is perfect for personal use and to help determine the financial position of your business. The most ideal time to start this budget is in the first year of business, however, if your business is already running, today is the next best time to start.
Planning Income Allocation for Business Owners
Identifying what business expenses and personal expenses you have will portend what a business owner’s personal income will be for the year. To efficiently budget your salary, you must write out every expense so that you can see exactly where your money is going for each category.
Before you start adding and subtracting you need to take into consideration every possible expense that can arise during the year including loans, interest, debts, investments, savings, taxes, emergencies, and more. Make a list of all these overhead costs and categorize them into tax savings, business loans/ debts/ operating expenses, business savings, personal expenses, and personal savings.
It is a good idea to budget your salary yearly so that you learn to live consistently knowing your personal budget and current lifestyle won’t change for a while unless you work very hard toward the business. This can serve as a great motivation factor. Sometimes it may be an intelligent decision to live ‘broke’ for the first few years, and once financial goals for saving and income are reached, allow yourself to indulge a little. A business will make you money, but sometimes, you must first invest your money for the entity to convert it to considerable amounts, causing your money to work for you.
How much should a business owner pay themselves? To determine how much net income will be left to be used toward your salary, use the quick formula below.
Net Income = Gross Revenue – Expenses
To dive in deep, let’s use the following steps to review what needs to be considered when a business owner is determining their salary. These steps will ensure that taxes and expenses are paid, savings are growing, and that you are getting paid reasonable compensation, ultimately determining the lifestyle you will have to adapt for the year to come.
#1: Tax Expense Saving
One of the biggest mistakes a business owner can make is not to save any or enough money to cover the taxes that they will owe to the state and IRS at the end of the year. If you are unable to pay this you will have a high tax liability. When filing your yearly personal income taxes, the amount of taxes owed will be calculated for you. Upon completing your tax return, you will receive estimated quarterly payments that you must pay.
For tax purposes, a business owner should save 30% of their income, or ask their accountant to see what tax rate they have based on the structure of your business. Different business structures that affect the tax law include sole proprietorship, partnership, limited liability company (LLC), c corporation, and s corporation. Depending on your business structure, your tax payment will go towards self-employment taxes like social security and Medicare, employment taxes, income taxes, and excise taxes.
When determining how much money you have leftover for other expenses after deducting your expected tax payment, use the following formula. You should immediately start putting money aside monthly so that you learn to be consistent with your tax savings.
Net Income – Tax savings = Business and Personal Access Income
#2: Business Expense
After you have determined your available income, which will be used for both yourself and your business, you must then identify the amount of money going toward your business expenses and establish a reasonable amount for your business’s savings.
First, write out all your monthly loans, credit card payments, and operating expenses that you owe. Keeping track of interest on loans would be helpful for the business owner since it is tax-deductible. If you can go through steps 1 to 4 and still have money left over, you may want to consider contributing higher payments to these debts. The less debt you have, the more money you have for other investments and savings regularly.
To see what you will have left after you pay the necessary debts, use the following formula to help you see how much money is left for other business investments.
Business and personal access income – Monthly Debt Payments = Business and Personal Access Income (2)
#3: Business Savings
Once you have accounted for your business debts, you can consider saving money in a separate account for future business ventures or emergencies. A good amount to store away for emergencies is at least 6 months’ worth of operating expenses including payroll. Of course, if there is an emergency, business ventures can wait.
Some business endeavors that may require capital are marketing campaigns, lead generation projects, training new hires, renewing, or obtaining new certifications, purchasing supplies, furniture, equipment, software, hardware, and more. It is always more advisable to have more money stored away, than less.
When growing a small business, all sorts of investments will pop up usually promising great opportunities for your business. If you don’t have much savings, be cautious about what you invest in. However, with funding, you can provide you and your employees with more tools for your line of business allowing the entity to prosper.
Owner Access for Salary = Business and Personal Access Income – Business Savings
#4: Business Owner Salary
Finally, since you have calculated all expenses including taxes, business expenses, and business savings, you can determine what your own salary will be. Additionally, you can calculate what your personal expenses and personal savings are going to be to truly see how much money will be left over for excess spending or further investments. Creating a personal balance sheet may be helpful at this time. Otherwise, you can begin to itemize all lifestyle expenses that you usually incur during the year just as you’ve done in the previous steps.
If your personal expenses are very high, you may want to refer to the next section of this article regarding ‘living on a budget’. If this is the case, do not panic just yet. If you fulfill your promise and duty to be an even better business leader as the year goes by, your next year’s salary will allow for more leisure spending. It is important to note that many business owners do not live off a lot in the first few years of their business. They understand that if they put in their time and money now, they will receive a greater return on their investment in the future.
If your personal expenses are not large enough to be a detriment to your salary, you are in a good financial position. There are a few options with what you can do with this excess money. You can use it to pay back loans or debts faster, invest it immediately into something beneficial for the business, save it in the business saving account, invest or save it for personal use and funding, or spend it at your leisure. Be sure to think about every decision very thoroughly before choosing any one option.
You need to remember to always set aside savings for yourself also, so you do not dip into the business savings account. Personal savings can include investment accounts like retirement funds (IRA/ Roth IRA), stocks, bonds, mutual funds, real estate, annuities, CD’s, and more!
Owner’s Access for Salary = Business Owners Salary OR Owner’s Access for Salary = Business Owner’s Salary + Additional Business Savings/ Business Expense Payment
How to Manage a Lifestyle with a Set Salary
At the end of step #4, you will have a number that either resembles a secure or not-so-secure financial position. Of course, it is always more desirable to have money left over at the end of a budgeted year, but this may not happen yearly, especially when first starting a business.
As a business owner, you will have years where you may not have enough money to live the normal life that you are used to living. However, if you budget your spending and work hard consistently for years, your own business will begin working for YOU and you will eventually get to live a more lavish life. Refer to the tips below to help you live on a budget or live lavish.
Living on a Budget
To ensure you are putting the most amount of money possible back in your business, you should consider only paying yourself enough to get by. Necessary personal expenses include rent, food, bills, water, and other things that are needed as time proceeds. Although food is a necessity, you should avoid fine dining and instead buy food that is nutritious but not overly expensive.
Living expenses need to be paid for you to be functional and productive at work, this includes buying fresh fruits and vegetables to maintain a healthy diet and having a gym membership so that you exercise.
DON’T: Purchase high ticket items that aren’t for your business, go on shopping sprees, go to exclusive/fancy restaurants, travel unnecessarily, lend money
DO: Delete yourself from your favorite store’s email marketing, understand where spending is going to, invest excess money that will make you a high ROI, make additional cuts in spending if necessary
Once your business makes enough profit to leave you, the business owner, with leisure money, you can spend a little more freely. If you have had to live on a budget in the past, you can finally spend money on professional clothing, new technology, books, pay off debts completely, furnishing your business office or employee rooms, investing more money, endorsing employee benefits, offering raises, and overall raising your standard of living.
Although you are finally able to pay yourself the salary you have been yearning to receive over the years, be careful with excessive spending. Be sure to maintain a healthy monthly budget for spending so that funding is still available in case of an emergency. As your business grows, your emergency fund will need to grow too since the cost to operate increases. Of course, you should not forget to invest in yourself first every year before spending all of your new salary.
An individual is forced to take a financial risk when they start a business. Small business owners, especially, may need years of paying themselves a low salary for their business to be profitable in the future. Bookkeeping personal finances and business expenses will enable your business entity to grow through your dedication and hard work.
Although determining your own salary is the benefit of being a business owner, you must plan for all possible cash flows, both positive and negative. If you find to have some extra funding at the end of the year, strategically think about whether you will keep it for yourself, invest it back in the business instantaneously, or place it into your savings. The best thing you can do for both yourself and your business is to stay in the habit of budgeting!
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