As a business owner, you may be unsure whether to pay yourself first, calculate a bare-bones salary or take random draws from business profits. Getting a paycheck regularly incentivizes you to keep growing whether your company is in a startup phase or has been in business for a few years.
Additionally, when you pay yourself, employees and investors see you as a committed entrepreneur. What’s more, the IRS views your business as a legitimate enterprise, not a hobby.
Even when deciding to receive compensation regularly, how do you determine what amount to pay yourself?
By reading this post, you’ll learn what gross pay is, the importance of calculating your salary, and methods you can use to compensate yourself for a job well done.
What is Gross Pay?
Gross pay is the beginning amount paid as a salary (plus applicable overtime) before withholdings and deductions are subtracted.
For the hourly pay, the pay rate is multiplied by the total hours worked. For any overtime hours worked, there’s a different rate that is added the sum to the gross pay.
An annual salary is divided equally into a specified number of pay periods per year, generally 12 (monthly) or 24 (fortnightly). In some instances, salaried workers exempt from being paid overtime must be paid for working extended hours when their weekly salary falls below a specified minimum established by the Department of Labor.
Why is knowing how to calculate your salary important?
There’s no one-salary-fits-all formula when calculating your pay. Businesses vary by type, legal structure, and other determinants that affect how much salary a business owner pays for services and expertise.
Along with these considerations, when a business owner knows how much it costs to operate the business, it’s possible to project his/her salary easier.
It’s a common practice for a small business owner’s salary to increase as the business grows.
How do you pay yourself as a business owner?
There are several ways you can calculate a fair salary for yourself:
1. Pay for the basics
Having just enough to get by means there’s money for food, bills, and other living expenses.
Create a spreadsheet and list your personal expenses, credit card debts, and loans you pay within a year. The total amount divided by 12 is the minimum pay you’ll need.
If your debts aren’t excessive, you can use money from a savings account to pay them off. Then, you won’t need to allocate as large a wage.
Likewise, you can take a close look at your business’s overhead. You may be able to reduce labor costs, trim production costs, and streamline your operation to cut expenses.
Once your business breaks even and stays stable for at least a year, you can consider increasing your salary based on your business’s rate of growth.
For instance, monitor how much profit increases per quarter. If there’s a 10% increase and overhead costs and income remain constant, multiply your current salary by 10% and pay the new amount until profit rises again.
2. Pay for what you’re worth
This is a subjective determination based on what the market bears for an entrepreneur in your line of work.
For example, according to a 2018 report by Small Business Trends, the median salary for a business owner is:
💵$60,000 in restaurants
💵$62,449 for construction businesses
💵$55,000 for retail stores
Whatever salary you choose, divide the figure by 12 and pay the same amount each month. Make sure the amount meets the IRS requirement that what you pay yourself is reasonable compensation to carry on a trade or business.
For a salary to be considered reasonable, compare your proposed wage with your employees’ wages, your duties, and what similar business owners receive for the same role.
3. Pay owner’s draw
Before thinking about paying yourself a draw, make sure your cash flow covers utilities, rent, wages, supplies, equipment, and other expenses FIRST.
You don’t pay taxes on a draw since it’s considered a distribution of income. However, you do report draws as income and pay taxes on taxable net business income at the end of your accounting year. For that reason, draws can be risky when you haven’t set aside adequate funds to cover potential, future business taxes.
Depending on your business’s legal structure, you should consult the advice of a tax professional before using draws as a means of receiving income.
Moreover, even though there’s no limit on how many draws you can take, you should make consistent payments to establish a history of sound accounting practices.
4. Pay a salary and a draw
You can combine salary and draw payments when business profits warrant this type of payment arrangement. This works for established businesses that realize a profit each month and every year.
How to calculate your employees’ salary?
Knowing how to calculate a fair wage for your employees is important too.
Every successful company relies on a team of talented, focused, and motivated employees.
As such, it is vital that you are able to attract and retain a skillful team in order to ensure that your business remains in good health.
Your salary is important
Keeping your business on even keel may seem like a balancing act but you can make your financial situation worse when you don’t receive a wage to cover personal living expenses. A business owner can plan for business and personal expenses better by drawing a salary for the same amount each pay period.
Moreover, including your salary as part of your normal business expenses proves to a lender that you know how to manage your business should you ever need to apply for a loan.
When navigating an uncertain journey as a business owner, we encourage you to subscribe to the Camino Financial Newsletter and become a part of our growing community.
The newsletter is one way we strengthen our motto “No Business Left Behind” by offering free educational resources such as weekly business management tips, ideas, and ways to grow your business. It’s our way of coming alongside your business to keep you moving forward.