If you’re running a small business, there’s a good chance you’re not taking a salary.
How do I know this?
Overseas studies show that around only 50% of owners pay themselves – but a recent article by SmartCompany gives real examples of what successful Australian owners are paying themselves.
Why entrepreneurs delay their own salary
If you’re currently running your own business, I know you’re putting your heart and soul into the operation. If you aren’t, then you may as well be working for someone else.
And when you put so much of yourself into your business, failure isn’t an option.
Whilst there are many bills you absolutely have to pay, your own salary isn’t one of them.
As the entrepreneur, you can draw money from business profits when necessary, but you don’t always have to designate a set salary for yourself.
Only taking money when you need it, means you can continue to reinvest 100 percent of your profits straight back into your business.
When should you start taking a salary?
You should start taking a salary as soon as your business is making a reasonable profit.
But what is ‘a reasonable profit?’
Ideally, your business should be making profit (not turnover) in the tens of thousands annually at the very minimum before you can consider paying yourself. If it’s not, where will the money for your salary come from?
But the decision to take a salary should also be based on your personal needs. If your business is only making a $50,000 profit and you don’t need the money, it might be better to reinvest 100 percent of the profit into your business.
Remembering also, on the $50,000 you’ll need to pay $7,467 in income tax meaning your take home pay will be $42,533 according to the Money.com.au Pay Calculator.
On the other hand, if you’re struggling financially and living off loans, it’s best to pay yourself a reasonable salary.
How much should you pay yourself?
Many business owners pay themselves based on a percentage of profits. This system works very well to ensure the business remains profitable, especially when profits are low.
Most small business owners choose to cap their salary at 50 per cent of profits, so they can encourage business growth with reinvesting the remainder. It might be tempting to take a larger percentage when your business is in this growth stage, but this could stunt the business’s growth in the long term.
So, from the example above, if your business is making $50,000 in profits, you might pay yourself a salary of $25,000 annually. It’s not even close to what you’d be making as an employee of an established business, but unlike an employee you have the potential to make much more as your business grows – especially when you can reinvest the remaining $25,000 into your business.
If you were to take a salary of $37,500 from that same $50,000 profit, you’d only have $12,500 to reinvest.
So in theory, taking more at this stage could actually double the time it takes you to grow your business to the point where you can afford to take a reasonable salary.
When profits are higher
Let’s say your business is earning $800,000 in profit. Half of that would equate to a $400,000 salary!
But there are a few things you should consider first…
- Fair market value – When you reach this level, it’s time to start thinking about your fair market value. You should never aim to pay yourself much more than you’d reasonably earn for the same job elsewhere. In doing so, you could be stunting your business growth, and you don’t want to do that.
- Other employees – When profits are higher, you’ll also want to consider your salary when compared to the salary of your employees. Taking pay that is so far out of line with what everyone else earns can lead to some very disgruntled and demotivated employees. Naturally, the total payroll will be deducted from business profits, so this is an important consideration.
- Hourly rate – When you come to an estimate for your salary, consider about how much you’ll be making per hour. This will give you an indication of whether you might be over- or under-valuing your services.
The decision of when and how much to pay yourself can be a tricky one, but it’s important to take time and consider all factors. In the early days, this often means personal sacrifice in the form of no salary or a small one. But if you invest wisely, your business will grow quickly.