stages of development - International Business Growth Radio Network

(Money Matters) How do I pay myself? - Kasfia Rashid

7/2/2021

Kasfia Rashid - “Money Matters with Kash the Bookkeeper”

IBGR.Network - PROFIT Radio. Everything a business owner needs to start, grow or exit a business. GROW WITH US.

Introduction:
Hello! Welcome to Money Matters- Ask the bookkeeper series, the accounting show answering burning accounting questions! You know, the ones you would only ask your best bookkeeping buddy!

Each show will have one main question from the audience with supporting questions from my various travels. Have a question to ask? Don’t be shy, step right on up! You can submit your questions directly to Hello@kashthebookkeeper.com! You may hear your question aired live across the globe!

We have discussed Assets and Liabilities questions and today we move forward with Owner’s Equity! Owners’ equity rounds out one of the basic equations of accounting:

Assets = Liabilities + Owners Equity.
We can rearrange this equation to say:
Assets- Liabilities = Owners Equity.

Catch up on the concept from last season’s podcast here: https://pod.co/money-matters-with-kash-the-bookkeeper/1-money-matters-owners-equity-you-are-worth-it-kasfia-rashid

Today’s question is at the forefront of every business owner’s mind : How do I pay myself? The sassy bookkeeper answer is : “With a check” hahahaha. But no, seriously, when a business owner asks this question what they are really asking is “ How MUCH do I pay myself?” Now, figuring that out, is a whole other process. One we will be diving into today!

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Show Objectives - The Why

One of the main reasons to start a business is to simply make a living. Yes, of course, there are other benefits that come with starting a business and other reasons to start a business. Let's be transparent for a moment, if you own a business you started this business in order to support a lifestyle. At some point you are going to want a return on your investment from your business. However, you don’t want to suck your business dry! Finding the right balance between how much to re-invest in the company and how much is needed to support your life-style can mean the difference between a thriving business and a failing hobby.

The National Federal of Independent Business says:

If you’re just starting out, the biggest determining factor for your pay is going to be your business’ cash flow. Wages, expenses, and all immediate obligations must be covered with cash. With limited or no cash flow—a reality for many startups—you might operate for a while without a paycheck, let alone a predictable salary.

Later in your business life, you may be able to take money from your business on a more regular basis, based on your personal financial situation.

I agree with most of that. I don’t agree that “as a start up, you may have to operate without a paycheck for a while.” If you plan your business correctly, with the appropriate legal and tax setups, there should be no reason that you are not starting off making a profit. Now what to do with that profit….?

What You Need to Know - The What
Once you have a profit in your business ( more money coming in than going out) you have two options : 1. Take it out of the business through a paycheck or a draw or 2. Reinvest it in the business.

Maybe you’ve made the decision between a salary and a draw, but now you’re not sure how much you should be taking out of the business for yourself.

As mentioned earlier, this isn’t “a one answer fits all type of situation”
Data from Pay scale shows that the average business owner makes $70,220 per year, but that takes several different things into account.

Here are a few things that you should consider as you are pondering this problem:

Business structure: Your business entity impacts a lot of your decisions. Many entities don’t allow you to take a salary, meaning you’ll need to take an owner’s draw.
Business performance: Regardless of which way you choose to pay yourself, it’s important to remember that your compensation as the business owner isn’t set in stone. You can make some changes as you consider your business’s performance. You should only pay yourself from your profits and not overall revenue. So, if your business is doing well, you might be able to increase your compensation.
Business growth: While performance is an important consideration, so is the current stage of your business. For example, if your business is a relatively new startup and in a stage of high growth, you’ll likely want to reinvest a lot of the profits back into the business, rather than pocketing them as compensation for yourself.
Reasonable compensation: Only taking a $10,000 salary from your company each year is going to raise some red flags with the IRS. Make sure you familiarize yourself with the IRS’ guidelines and ask around to figure out what a reasonable salary for your type of work is.
Personal expenses: That reasonable compensation will give you a starting point, but it doesn’t need to be your only answer. You have personal expenses—from your mortgage or rent to your savings account—that you need to fund. Get a good grasp on what those expenses are, so you can make sure you’re taking home enough to cover them.

Those considerations will help you land on a suitable number to pay yourself, whether you take it as a salary or a draw.

What You Need to Do - The How

Grab that paper and pen ladies and gents, it’s list making time! Calculating your starting salary or owner’s draw can be a daunting task. You need to fully know and understand your numbers ( personal ) and your business’ numbers before making this decision. Keeping in mind, you can change it!

One of my favorite ways to answer this question is to utilize the ‘Profit first” method. If you have never heard of the book, check it out here:

While the book has multiple charts, figures and graphs to build a profitable business using the cash in your bank account, the basic concept is the same as an envelope system : Split each sale into the main parts of a business - Expenses, Reinvestment, and PROFIT! Those are the lists you are going to need for your business and your lifestyle. Write down all of your “normal” expenses, your upcoming reinvestment expenses, and your lifestyle expenses. Add them all up and we have our “floor”. Next it is our job’s as business owners to bring in enough Revenue to meet that floor.

As the business grows, so will the floor. With more revenue coming in adjustments must be made to keep the same percentage of profit across the business.

But, Kash, this is all very complex, can’t you give me some easy to follow steps to calculate this?
Well…………… okie.. Since you asked so nicely!

I use this method in my personal life.
For each $100 in sales :

$30 should be set aside for taxes/savings right off the top.

$35 -$50 should be used to run the business/ reinvest
$20 to the owner

Articles :

Additional Resources

Check out Kash’s Youtube Playlist: Bookkeeping basics for small business owners.
Want to learn how to use QuickBooks? Click here for three free videos!
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Shows:
Previous: How do I put a debt schedule together?
Next: How do I track personal expenses?

Written by Kash the bookkeeper
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