What we're talking about
People start businesses for a multitude of reasons, but one of them might be so you can pay yourself more – or more equitably – than a full-time job can. Despite that, and often in order to ensure consistent cash flow, more than half of business owners have at some stage ended up not paying or underpaying themselves.
Especially when you're responsible for monitoring and adjusting all of your expenditures as a business owner, paying yourself a salary can feel like an additional cost that can easily be avoided. But it's important that you don't gloss over your own salary for long – and, ideally, not at all. More than three in five founders surveyed by finance technology brand Kabbage reported feeling anxious due to business cash-flow problems, which will only be heightened if they're struggling to make ends meet at home.
Why it's important
Even when you're your own boss, paying yourself is an important signal of the value of your time and expertise. Sacrificing payment to yourself can also impact your personal life, which will affect how you're able to run and grow your business. You might begin to lose motivation and edge into burnout if you're not being rewarded for your work.
How a founder decides to go about paying themselves depends on a number of factors, and the amount might change over time. For instance, an early-stage founder might pay themselves the absolute minimum, whereas a business that has consistent revenue can afford to pay its founder a competitive salary. It'll also depend on your industry and the legal structure of your company.
Things to note
• Work out your expenses. A lot of the decisions around paying yourself depend on your existing cash-flow needs, including expenses and projected profit. It's also realistic to assume that it probably won't be lots to start with. If you want to pay yourself more as you grow, you'll need to make a plan and keep a close eye on your finances.
• Know your legal structures. This will depend highly on where your business is based and the legal way that it's registered. For instance, if you're a freelancer or sole trader, you can usually draw money straight out of profits. On the other hand, as a company, you might have to factor your salary into wider financial plans. It's best to have an accountant involved and to keep records as best as you can.
• Keep your accounts separate. It's important to keep your business and personal banking accounts separate to prevent any tax confusion. This will make bookkeeping and tax filings easier and less costly. It also helps people understand how the business is doing. For example, if you have to keep putting your personal money into your business account, it's a clear indicator that revenue is lacking. Remember to be as consistent as possible with how much you pay yourself, to avoid any tax confusion.
Here's how to decide how much you should earn
1. Calculate your income and expenses. If you don't already have a budget, it might be worth creating a profit and loss statement for your business. This is the simplest financial statement you can make for a business – it'll give you visibility of all the cash coming in and out.
2. Make sure you have an emergency fund. Even if the difference between your revenue and costs is enough to factor in your salary, you should still put some money aside for spontaneous expenses that might arise. Conventional wisdom suggests having three to six months of expenses banked away just in case. For many small businesses, this won't be possible – but it's something to aim at.
3. Calculate your personal costs. How much you should pay yourself as a founder depends on your personal needs. Personal needs drive salary, so calculate – at the very least – how much you need to live on. Ultimately, you need to be financially stable so that you can dedicate your full attention to your business.
4. Know your legal structure. How you pay yourself (a bank transfer or a proper paycheck through a payroll service provider) will depend on how your company is legally registered and the country it's registered in. And, within that, there are multiple ways you can pay yourself: from a salary that's factored into your finances as a cost, to dividends of your business' profits to taking draws of the profits. There'll also be separate tax implications for each. Speak to an accountant at this stage to advise on best – and the most tax-efficient – practice.
5. Be realistic – and fair. Now it's time to factor your salary into your budget. We recommend paying yourself like you would any other employee on your payroll, so that your salary is treated as one of the fixed costs of the business. If this isn't possible without your business going into the red, you'll need to look at ways to either increase income or minimize expenses. If you're paying yourself from your profits, your business needs to be breaking even at the very least, and you should be able to guarantee that there'll be consistent enough revenue to factor in your salary.
6. Be transparent – and keep records. As you would with all of your other expenditures, keep a record of any time you pay yourself. This bookkeeping will be vital for tax purposes as well as for understanding how your business is doing. If you have staff who you already pay, you might also consider letting them know that you're now paying yourself a salary and how much it is.
7. Grow with your company. Say your business' revenues have grown by 20% over the past year and you anticipate that growth will continue in the future. You can adjust your own salary along with that growth – and, ideally, increase your team's salaries accordingly, too.
8. Look ahead. Try to project future earnings and expenses going forward. Set time aside every week to regularly update your budget or profit and loss statement. If you're willing to spend a little on small business accounting software, this process will speed up considerably because it'll mostly be done for you. This can help you understand your potential for income growth and the general sustainability of your company.
• Paying yourself can often get left to the bottom of a business owner's to-do list. Instead, put it at the top of your list. Being compensated for work will ensure your own financial security, which will directly impact your business' long-term sustainability.
• Before you work out how much you'd like to pay yourself, make sure you have a good understanding of your existing expenses – and factor in emergencies.
• The way you pay yourself will depend on the legal structure of your company and where you're based. You should also keep a record of your salary for your accountant when it comes to filing taxes.
Perspective. As a business owner, you can usually choose whether you want to set yourself a salary or take a portion of profits in the form of dividends. This article breaks down each legal structure and the implications for you as a founder.
Example. It's highly likely you won't be able to pay yourself the equivalent of a full-time salary to start with. Here's an honest take from one founder on how long it takes to get to profitability – and some ideas for ways to supplement your income in the meantime.
Tool. Even if you have an accountant, you'll want to invest in a good payroll tool. Check out Gusto or QuickBooks.