How to Pay Yourself as a Small Business Owner
As a small business owner, you’ve invested a lot of time and money into your small business. You should be compensated just as any employee would be. But how should you compensate yourself and how much? Depending on the type of business you own, paying yourself will look different.
Salary vs. Owner’s Draw
One method of paying yourself back is receiving a salary. You can include yourself on payroll along with the rest of your employees, and your compensation will be a fixed amount every pay period. You will still be able to give yourself a raise or a pay cut if circumstances change. Your salary can be paid with a check or a direct deposit. A benefit of this method is that federal and state taxes will automatically be withheld from your salary. You might prefer having a set salary because it will be easier for accounting purposes.
Another method of compensation is taking an owner’s draw, paying yourself from the business’ profits or capital. Like a salary, you can write a check to yourself or deposit the funds directly into your bank account, but this method is more flexible than a salary because you can withdraw more or less funds for yourself depending on how your business is performing. Some prefer this method because of this flexibility. If the business is low on cash, you can decide to pay yourself less for that period and make sure other expenses, like worker salaries and rent, are taken care of first.
When deciding how to pay yourself, you should factor in the type of business you run. The legal structure of the business could place restrictions on how you as the owner are compensated. If you run a partnership or a sole proprietorship where profits pass through the owners, you will take an owner’s draw. If you are an owner of a corporation, you will most likely receive a salary. You can also take compensation from shareholder distributions and dividends.
When determining how much you should pay yourself, you can base your compensation on your personal expenses. This method is preferred when you do not have a secondary job or source of income. Reviewing your living costs and your business’ performance numbers will help you determine how much you can pay yourself.
Alternatively, you might decide to pay yourself a percentage of business profits. This will mean that your compensation fluctuates with the success of the business. Being paid based on profits could be a motivating factor in putting in the work to make sure your business is profitable.
A good practice business owners should follow is to pay themselves modestly. Cash flow is crucial for a business. Writing yourself a big check might not be sustainable with your profit margin and could have detrimental effects on your business. Make sure business expenses and liabilities are paid first before paying yourself. Paying yourself less could also result in paying less taxes and the extra money can be reinvested into your business.
Personal and Business Don’t Mix
Personal and business finances should be kept separate. Even if you are the sole owner and all profits and earnings go to you, having a separate checking account completely dedicated to your business will help maintain accurate financial records. You can link your personal and business checking accounts to make transferring funds between the two a quick and simple process. However, whether you are writing checks or making transfers, you should take money from your business sparingly. Make sure that every transfer is written down in your financial records.
Budget for Taxes
When you take an owner’s draw, you will have to pay taxes on it later. You will be responsible for paying state, federal, Social Security, Medicare, and possibly other taxes. Since these won’t be taken out of your paychecks, it is important to budget and ensure you have the funds available to pay them every quarter.
If you pay yourself by receiving a salary, federal taxes will already be withheld. Your salary can be reported as a business expense which can reduce your company’s net income on accounting records. Be sure to consult with a tax advisor to be aware of any tax implications that come with paying yourself with business funds.
Compensation Should Be in Your Business Plan
Many business owners exclude themselves when building their business model. It’s not uncommon for a business owner to not receive any compensation during the first few years of running their business. It is up to your discretion whether or not you want to pay yourself, but keep in mind that your time and effort has value. You are your top employee. If you aren’t paying yourself now, you should plan to pay yourself in the future as your business grows and reaches new profit milestones. To learn more about how to manage business and personal finances, call George Myers today at 956.519.5995 or visit PlainsCapital.com.