Determining your small business owner salary can be complicated. But, it’s not a big obstacle if you go about it carefully. The central dilemma–as we have noted elsewhere–is that if you “over-compensate yourself, you can put undue pressure on yourself and the business could suffer.” On the other hand, by undercompensating yourself, “you may be unable to give your business a fighting chance.”
To overcome this obstacle, here are key points and action steps to consider:
Focus on profits, not revenue.
Revenue is the money your business derives from sales. But, it’s not the same as profit. Before you see any profit, the income you collect from sales must go to paying your employees, your taxes, overhead expenses and fixed costs.
Therefore, a percentage of profits is the best rule of thumb to follow when determining your salary. According to NFIB, an actual salary figure should be “based on a percentage of profits over the past 2 to 3 years,” not “based solely on projections for the upcoming year or years,” even if you have contractual assurances of business yet to come.
Make sure you still set aside the right percentage of business earnings for:
- A cash reserve (or emergency fund) account
- Estimated tax expenses
- Paying off debts
- Funds to go back into the business for operating costs, fixed expenses, marketing expenditures, etc.
You can funnel what’s left over after paying for these business expenses into your own small business owner salary. NFIB adds that “most owners of profitable small businesses don’t take out more than 50 percent of profits for themselves.”
Get a sense of what other small business owners pay themselves.
It takes a bit of research, yes. But, finding out what owners of comparable enterprises pay themselves can help you determine your own salary requirements.
On salary comparison sites such as Payscale or Glassdoor, you can look at positions similar to your own. It might help you grasp what’s “market appropriate” in these areas. Often times, the same information is available in industry trade magazines or similar materials.
Keep in mind: Business owners on the east and west coasts generally pay themselves at a higher rate than their counterparts in the south or the Midwest regions.
Consider market-based wages.
Ask yourself, what would you pay another person with the same amount of skill and experience you possess? Other relevant factors include range of expertise, business contacts and overall scope of knowledge.
The salary figure you determine, based on these factors, gives you at the very least a ballpark estimate of what’s appropriate to pay yourself.
Be sure to pay yourself on a regular schedule.
Once you’ve determined what your salary should be, don’t look at the process as something you do from time to time, as profits permit. Instead, according to the accounting software firm Xero, establish payments “for you and your employees … and stick to them.” Following this system, “you’ll get used to the amount of money you receive and won’t have to worry about taking out occasional large lump sums.”
In other words, decide upon an annual salary and then divide that amount by 12 (for monthly payments). Don’t deviate from that figure. Additionally, check in with your accountant to make sure this amount matches what the IRS considers “reasonable compensation” for running a trade or business.
Many factors go into determining the appropriate small business owner salary that’s right for you. Remember that if your business is in the delicate startup phase, you’ll probably have to survive on the bare minimum. This is because all available funds must sink into the business enterprise in order to stay afloat. As time passes and when profits become tangible, then it’s time to start looking at how best to ensure you receive an appropriate base salary.
And for good reason–you’ve earned it!