How Much Should Small Business Owners Pay Themselves
- 23.05.2022 12:00 pm
An unseen part of running a small business that many people overlook is the act of paying out a salary. Too high, and you’re testing how long your business can run with reduced profits. Too low, and you may struggle yourself to stay afloat, especially if you live in an expensive area.
If you’re part of the 31.4 small businesses in the U.S.A., you may be wondering how much should small business owners pay themselves? We’ll break down all the steps that you should run through, making sure you understand the math behind the salary that you pay yourself.
Let’s get right into it!
Small business owners make, on average, $61,756 a year. Yet, of course, this is the average, with goalpost figures spanning upward to $120,000 and as little as $30,000.
There are six general steps that you should go through when deciding on how much to pay yourself; these will help you cover all your bases before you start shelling out money on your own salary.
Consider moving through these stages:
- Calculate your net income as a business
- Save for taxes
- Cover any debts
- Add to the business savings plan
- How much do you need to live?
- Draw everything together
Let’s break these down further.
The very first step on your journey to working out how much you should be paying yourself as a business owner is to find out exactly how much your business is generating monthly. This is one aspect that is very easy to calculate, as there are very few metrics to take into account.
First of all, work out how much profit your business made in a one-month period. Over that same period, minus all the expenses that you had to payout. In this case, an expense is anything that you pay to run your business, whether that be paying employees, buying supplies, renting a location, or buying a domain for your store.
The equation looks like:
Gross revenue - expenses = net income.
Once you have this first figure, you’ll have a much easier time working out everything else. Of course, this is the absolute maximum that you could pay yourself. However, that would be fairly irresponsible as there are a lot more factors to consider if you want to stay in business for more than a few months.
As the famous quote goes, nothing in life is certain - apart from death and taxes. This quote rings true for your business, with corporation tax being something that you’re going to have to pay annually. While the exact amounts that you’ll pay depend on how much revenue your business is generating, a good baseline to shoot for if you’re not sure would be 30%.
That means from the total net profit, you should instantly put 30% aside to have ready to pay taxes when the time comes. If you want to work to more specific numbers, then we recommend that you talk to an accountant that will read through your actual financial accounts.
If you don’t put aside this money, you could find yourself in a very sticky situation when it comes time to pay your taxes. With late fees and penalties, it’s always good to stay on top of what you have to pay ahead of time.
When starting a business, not everyone has the initial capital to launch their plans straight off the bat. Due to that, many take out business loans, giving them the initial funds, they need to start operations.
If you fall into this category, we imagine that you’re fighting a high-interest rate alongside your monthly payments. We suggest that you work on paying off these debts before thinking about paying yourself.
Did you take out debt to start your business? If so, you need to cover this before you start paying yourself large sums.
Another thing you should factor into your equation before you pay yourself is the amount you are aiming to save. Within a business, you should always have cash available for growth opportunities. Equally, creating an emergency fund is an early goal that every business should have to protect itself if something goes wrong.
Typically, you should aim to save at least three months of operations costs just in case you suddenly stop making a profit. This will protect you and ensure that you don’t have to eventually file for bankruptcy.
Equally, creating a savings pool will help whenever you need to make any purchases. Any business needs, from equipment and software to paying your staff, must come from somewhere. Due to that, it’s your responsibility to make sure there is a savings pool.
Calculate how much you want to save in a year, then divide that by 12 and put that amount aside every month so that you stay on track to hit your savings goal.
Finally, part of paying yourself a salary needs to take into account how much you actually need. If you pay yourself too little, you may not be able to afford rent or groceries, which would exactly be the best situation for you to end up in!
Take into account how much you pay each month in rent and any other general expenses that are predictable each month. Then add things like groceries and however money you think is appropriate for extra expenses.
If you’re good at tracking your expenses and monthly budget, it may be very easy for you to come up with a number in this section.
If not, go through your bank statements for the past few months and take the average of all the expenses which would be vital for you in the average month. That gives you a minimum of how much you need to pay yourself.
Now that you’ve got something written down for every single one of those categories, it’s time to bring it all together.
Start with the total net amount your business makes in a month. Next, deduct taxes, debt payments, and business savings.
You’ll be left with two numbers, one that’s your minimum possible amount (the amount you need to pay just to live each month) and the above figure.
These represent the minimum and the maximum that you could pay yourself. Between these numbers is completely up to you, but remember that if you’re looking for long-term longevity, putting more money back into the business is always the better option.
When deciding how much to pay yourself as a business owner, the best option is always to pull up your spreadsheets and get to work on the mathematics. While not the most exciting answer, this is the only true way that you can calculate the maximum and minimum that you should be paying yourself.
With these figures calculated, you’ll be well on your way to paying yourself a salary while also ensuring that your business has a cushion of funds that will weather through any storm. Best of luck with your small business!