By Bert Seither, Vice President at 1800Accountant
About the author: Bert Seither is the Vice President at 1800Accountant, the nation’s leading accounting and consulting firm for small businesses and entrepreneurs. For over a decade, Seither has assisted thousands of small business owners by helping them achieve financial freedom.
Small business owners often point to a variety of reasons that ultimately lead them to launching their own ventures. Freedom, flexibility, and the opportunity to pursue a passion are just a few of these. However, entrepreneurs in all industries almost always agree on one thing about starting a new business – making money. While it’s tempting to take a big cut of any income a company generates, there are some factors to consider before writing yourself a paycheck as a business owner.
Regardless of the type of business entity you own, the primary figure you should be looking at to determine an appropriate salary for yourself is the amount of income your enterprise is generating. Keep in mind that in the midst of the startup phase of any new company, you’ll probably have to limit the amounts on your paychecks due to how much money you’re spending to build your business foundation. But once you see some substantial cash flow coming in, you’ll find it much easier to pull a reasonable amount from this figure for your own personal use.
Based on research, small business owners who’ve enjoyed success typically set aside a maximum of 50% of the money their companies bring in for their own salaries. As far as a timeframe goes on when you should compensate yourself, many business owners stroke monthly checks to themselves, but this will certainly depend on how often income is being generated from customer purchases. You could have a biweekly salary like you did at your day job, or you might have to wait a few months before digging your hand into your business bank account.
Sole proprietors have a fairly straightforward road to trek when defining their personal salaries. This is because a good number of sole proprietorships consist of just one individual manning the ship, hence the term “sole.” In essence, this means all of the income on the table is at the behest of the business owner. Of course, it probably wouldn’t be too wise to claim 100% of it as a salary because of expenses and taxes. This is why a traditional salary calculation method for sole proprietors is to add up all income and then subtract business expenses and taxes from this income amount. The resulting amount you come up with could be a decent estimate of your salary.
There’s a little more gray area when putting a number on salaries for small business owners with one or more business partners or employees. In these cases, examine some data related to your previous and current profits. Also, make reasonable profit projections on how much you think you can make in 3 months, 6 months, a year, and even a few years out. Then account for your business expenses, how much will go to any employees or contractors, and how much you can afford to pay yourself. If you operate a corporation or LLC, the term “fair and reasonable salary” is often applied to business owners by the IRS. This means you should pay yourself an amount that’s within reason and along the lines of how much your fellow business operators are giving themselves. If you are writing yourself outrageously large paychecks, you just might get an extra glance at your income tax return.
Because small business ownership involves a wide array of financial requirements and figures, it is highly recommended to seek advice from an accountant when determining the salary for a business owner. You certainly want to take enough money out of the business to cover your personal needs, but you also don’t want to pay yourself too much where your business actually suffers from it in the end.