One of the greatest perks of owning a small business is flexibility. You can set your own hours and salary. You can plot the firm’s trajectory without consulting your boss, upper management, or even corporate policy. But that same flexibility may become a curse if handled unwisely. A small business owner without discipline and a well-thought-out strategy may fall into serious financial trouble. Employees in larger firms often rely on the human resources department to establish pay scales, retirement plans, and health insurance policies. In a small company, all those choices – and many more – fall to the owner, including decisions about personal compensation.
While there’s not a one-size-fits-all formula for determining how much to pay yourself as a business owner, here are three factors to consider:
* Personal expenses. Tracking your business and personal expenses separately makes it easier to track the firm’s cash flow, and lets you know how much salary you can realistically draw without hurting profitability.
Start with your household budget; then determine how much you’re willing to draw from personal savings to keep your household afloat as the company grows. For a start-up company, owner compensation may be minimal. Beware, however, of going too long without paying yourself a reasonable salary. Be sure to document that you’re in business to make a profit; otherwise the IRS may view your perpetually unprofitable business as a hobby — a sham enterprise aimed at avoiding taxes.
* The market. If you were working for someone else, what would they pay for your skills and knowledge? Start by answering that question; then discuss salary levels with small business groups and colleagues in your geographic area and industry. Check out the Department of Labor and Small Business Administration websites. In the early stages of your business, you probably won’t draw a salary that’s commensurate with the higher range of salaries, but at least you’ll learn what’s reasonable. This is important because there are some limitations as to reasonableness of compensation.
* Affordability. Review and continually update your firm’s cash flow projections to determine the salary level you can reasonably sustain while keeping the business profitable. You should consider your salary as one of the most important expenses and should always be paid. As the company grows, that level can be adjusted upward. Bonuses can even be paid for those short time increases.
For assistance with this issue or other business concerns, contact our office.
Written by: Doug Rodrigues