How much should I be paying myself?

Many business owners fail to pay themselves a proper wage and often rely on taking drawings from the business in order to survive. This is especially so in the first few years of opening a business. On the other end of the scale we have the business owners that drain too much funds out of their business inhibiting any potential growth. Either way the question inevitably arises ... just how much should I be paying myself?

Running a small business involves more than selling your wares to the market - all those critical supporting functions such as IT, Marketing and Human Resources are often left to the business owner to perform who is also responsible for keeping the business competitive and profitable. It is difficult to put a figure on just how much the owner is worth to the business. 

There are four main factors to consider in determing how much to pay yourself:

1. Earning a Fair Market Wage
2. Return on your Initial Investment
3. Wealth Creation
4. What your business can afford

Fair Market Wage

How much would you earn if you were doing the same job for someone else? Or if you fell ill how much would you have to pay someone else to cover for you? If you're not aiming to earn more than that or if your business model isn't going to generate more profit than that - you may as well shut the doors and avoid all the paperwork and compliance that comes with running your own business altogether.  

Return on your initial investment

In addition to the above you want to receive a return on your initial investment. That is the personal funds you used to start up and/or any equity you have built in your business since. How much return on investment should you allocate for? You would want to be receiving more than if you had invested your funds by other means. For example you want to be returning more than you would have earnt if you deposited those same funds into a Term Deposit at a bank. 

You want to retire some day don't you?

Next you want to consider wealth creation and succession planning.  On top of your ordinary wage and any return on your initial investment you want to be earning enough to diversify into other investments so that you may build enough wealth to retire comfortably. Whether that means a retirement fund, putting aside to invest into real estate or investing in some blue chip stocks is entirely up to you and your financial advisors. 

How much should you be putting aside from your business for your own personal wealth creation?

This should be part of your succession or exit plan from the business, which is another topic entirely and not within the scope of this article. For the sake of putting a figure here most financial advisors work with a 50-30-20 rule* - which is a recommendation to save at least 20% of your net income. Admittedly that 20% would come out of your fair market wage if you were a salary earner.  But as a business owner you don't have to limit yourself to that - just make sure your business plans are realistic enough to give you the returns you budget for. 

Don't Forget to Factor in Income Tax

Depending on your business structure - eg whether you are trading as an individual or as a company or trust, you may be able to pay yourself a salary just like any other employee. You will then have had tax withheld at the appropriate rates and may receive contributions to your super or 401 plan as part of that salary. But if you are receiving any dividends from your company and/or distributions from your trust, either solely or on top of that salary; or if you pay yourself by taking drawings - you will have to factor in any income tax payable on those amounts.

How much your business can afford to pay

Finally you must consider how much your business can afford to pay you. While it is all good and well to decide you want to be the highest paid person in your field but if that is going to create a strain on your business and/or impact your business' future growth you might want to consider holding off until circumstances improve.

Build your goals into your business plan

Your personal long term goals and the business's long term goals are two different things (and can often conflict).  Having a clear outcome of what you personally want to get out of your business over your lifetime will help you drive your business in that direction and form the starting point for any forecasts or budgets you implement.

It is important that you allow for both in your business plan. Whether that means getting your start up IPO ready or building up a family business that you may pass on to your successor.  Putting the frame work in now will help you achieve those goals. 

Building up Equity

It can be hard to remain motivated when you are the lowest paid staff member on your team. If you are starting out in business or in a period of rapid growth - you may have to forego diversifying into other investments or even a wage altogether while you build up enough equity in your business.

Reinvesting in your business will create equity - you are still building up wealth as you are building up capital worth of your business. However I would refrain from relying on capital growth in your business as your sole source of building wealth - you might remember the saying about eggs and baskets.

Pay yourself first

You may have heard the age old adage that you should pay yourself first. While this is good advice as you cannot concentrate fully on building up your business if you are worried about how you are going to pay your personal rent/mortgage or electricity. If you are currently foregoing a proper wage make sure you are still paying yourself enough to live on comfortably

But having said that I feel obligated to add a disclaimer as I had a client take this advice a little too literally to the extent that they were not paying other key contractors during a period of cash flow problems. If you are not paying key personnel, who in turn aren't delivering results (as they aren't getting paid), this will affect future revenue, which will only serve to compound already tight cashflows. Running a small business always means juggling priorities. 

Assessing your Business's Viability 

So now that you know what you should be getting out of your business - it's time to assess your business viability. If your projected net profit isn't going to give you those returns or if you are continually having to choose between paying yourself and operating expenses and the equity in your balance sheet is going downhill - you may have to accept the fact your business just isn't viable at the moment. It may be time to review your business model - maybe you need to raise your prices or cut some costs.