As a small business owner, one of the most critical decisions you’ll make is how to pay yourself. It’s a delicate balance – you need to ensure your personal financial needs are met while also keeping your business’s financial health in check. So, how do you navigate this tricky terrain? Let’s dive in.
First, let’s clarify the difference between an owner’s draw and a salary. An owner’s draw is a withdrawal of funds from the business by the owner for personal use. It’s flexible and can be taken at any time. On the other hand, a salary is a fixed regular payment made by an employer to an employee, which in this case, is you. It’s consistent and can be budgeted for both personally and within the business.
So, which is better? The answer depends on your business structure and personal financial needs. Here are some pros and cons to consider:
Owner’s Draw Pros:
1. Flexibility: You can take money out whenever you need it.
2. Tax Advantages: Draws are not subject to self-employment taxes.
Owner’s Draw Cons:
1. Unpredictability: The amount can vary, making personal budgeting challenging.
2. Potential Business Impact: Frequent large draws can hurt your business’s financial health.
Salary Pros:
1. Consistency: Regular payments make personal budgeting easier.
2. Business Planning: Salaries are an expense, which can be factored into business budgets and forecasts.
Salary Cons:
1. Tax Implications: Salaries are subject to self-employment taxes.
2. Less Flexibility: You’re committed to a set amount, regardless of business cash flow.
Now, the million-dollar question: how much should you pay yourself? There’s no one-size-fits-all answer. It depends on your business’s profitability, your personal financial needs, and industry standards. A good rule of thumb is to start small, especially if you’re just getting started. As your business grows and becomes more profitable, you can gradually increase your pay. The average entrepreneur makes about $68,000 a year, according to self-reported salaries at Payscale, a compensation software company. However, your pay should be tailored to your business’s profitability and your personal financial needs.
If you’re taking an owner’s draw, your pay should come from the business’s net profit, which is revenue minus all operational expenses. This ensures you meet all business obligations (including paying employees, if you have them) before paying yourself. A good rule of thumb is to pay yourself a fixed percentage of the business’s profit so that your compensation can adjust according to the performance of your business.
There are other methods of taking money from your business, such as dividends and distributions. Whether and how you can use these methods depends on the structure of your business. Your fractional CFO can advise you on the pros and cons of each.
However, there are some common mistakes to avoid while paying yourself:
1. Mixing personal and business finances:
Always keep your personal and business accounts separate. Using a business credit card to pay for your personal expenses or not actually transferring your pay or owner’s draw from your business account to a personal account can lead to accounting complications and hurt your chances of getting a small-business loan.
2. Not budgeting for taxes:
If you are using the owner’s draw method, you should keep a part of every draw aside for taxes since they aren’t deducted upfront. As a business owner, you also have to pay taxes on a quarterly basis; accounting software can typically help with that. If you don’t budget for it, you risk being hit with a big tax bill, and you may not have the cash on hand to pay.
3. Never paying yourself or being inconsistent about it:
You may not pay yourself in the beginning, but ideally, your compensation should be part of your business plan. Your financial projections should include the amount of your salary or owner’s draw to help you understand what your business needs to grow.
FAQs:
1. Can I switch between an owner’s draw and a salary?
Yes, but it’s essential to consult with your accountant or fractional CFO to understand the tax implications.
2. Can I pay myself a salary and take an owner’s draw?
Yes, some business owners choose to pay themselves a modest salary for consistent income and take an owner’s draw as needed.
Deciding how to pay yourself as a small business owner is a crucial decision that requires careful consideration. Whether you choose an owner’s draw or a salary, the key is to strike a balance that meets your personal financial needs while ensuring your business remains financially healthy.
