Pay yourself first. Many small and medium-sized business owners have heard this over and over. While it may sound simple, once your business starts generating cash flow, it is easy to get caught up in the desire to stay ahead of debt and attempt to reinvest into the company before drawing a wage. With a profit-first mindset, all the same designations benefit from your business cash flow only the order they get paid differs.
For example, you would pay yourself first, cover all business expenses, and set aside a portion for taxes and reinvestment. As easy as that seems, the business structure you choose to operate your company will have an impact.
Sole Trader or Partnership
With a profit-first management system in a business operated as a sole trader or partnership, you pay yourself by withdrawing cash from the business. The government views those personal withdrawals as profit, and they get taxed annually. To help cover the tax bill, open a separate bank account and allocate a percentage of your monthly cash flow to go into that account. Come tax time, you should be able to cover it.
Company
If you own a company, drawing a salary is common. A salary is considered a business expense, and you will pay personal income tax on it. Small business owners sometimes change how they do this by drawing a modest salary. But dividends from profits are used to help top up their take-home pay.
How To Decide How Much You Pay Yourself
While it may be tempting to pay yourself the biggest income you have ever earned in your working life, there are factors to consider that will assist in determining the right amount. Ultimately, you must be sensible about your income figure. What you pay yourself must meet the needs of your household and those of your business.
Here’s How to Make That Happen
Your business is like a monster that needs constant feeding. In this case, you must ensure it has enough money to stay satisfied as each month passes. Here is a closer look at what you must consider.
Expenses
Business expenses are what make your business hungry. Create a list of the monthly expenses and when the bills for them are due. Also, set aside a percentage to cover taxes.
Rainy Day Funds
Things that cannot be planned. Anything that can create a business disruption is going to cost you money and impact on the cash flow of your business. If you build a rainy-day fund by stashing some cash regularly, your business can weather any storm that comes its way. A general rule of thumb is to have enough cash available to cover 30 to 90 days of expenses. The actual duration will depend on your comfort zone and the type of business.
Household Requirements
The other side of the coin is what you need to keep your home fed. This monthly budget will need to cover everything from mortgage and utilities to insurance, taxes, retirement planning, and all other costs within your home.
Trial And Error
Don’t expect to hit the perfect balance right out of the gate. But do expect to spend time tweaking here and there until there is enough money moving around to cover both your business and household expenses effectively.
How Much to Pay Yourself
Let’s face it, there must be a number next to your name as part of this balancing act, and if you do fully adopt a profit-first mindset, you can’t do it without a salary amount. But what should that be, and how do you determine it? As stated above, modest weekly or monthly pay is fair. You want to earn enough income to meet your household living expenses. This does not mean moving up to extravagant levels because your cash flow may allow it.
Think of your salary as the amount of money you need to maintain your current lifestyle, with possibly a couple of improvements. That should get you in the ballpark.
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Conclusion
Small and medium-sized business owners usually pay themselves after covering all other expenses first. With a profit-first mindset, you get paid first, and all other costs come next. It is not hard to implement once you know how much you need to keep both your business and household functioning properly.