One of the most exciting aspects of being a small business owner is the autonomy to control your financial destiny.
But with that freedom comes the responsibility of figuring out how to compensate yourself fairly and sustainably. It’s a crucial decision that impacts your personal finances, your business’s financial health, and even your motivation.
So, how do you find the sweet spot? Let’s dive into some best practices for paying yourself as a small business owner.
What are the different ways I can pay myself?
First things first, you need to understand the different ways you can pay yourself. The most common methods are owner’s draw, salary, or a combination of both.
An owner’s draw is essentially taking money out of your business profits as needed. It’s simple and flexible, but it lacks the predictability of a regular paycheck.
A salary, on the other hand, is a fixed amount you pay yourself regularly, just like any employee. This offers stability and can be easier to budget around, but it requires more formal payroll setup and may not be as flexible if your business income fluctuates.
The combination method allows you to benefit from the advantages of both. You might pay yourself a modest salary for consistent income and supplement it with owner’s draws when profits allow.
The best method for you depends on your business structure, personal financial needs, and tax implications. Consulting with an accountant can help you navigate these complexities and choose the most suitable option.
Determining Your Pay as a Small Business Owner
Now comes the million-dollar question: how much should you pay yourself? There’s no one-size-fits-all answer, but there are some factors to consider.
First and foremost, your business needs to be profitable enough to cover expenses, taxes, and reinvestments before you can pay yourself. Being realistic about your business’s financial capacity is crucial. Researching industry standards can provide a benchmark, although this shouldn’t be the only factor determining your salary. Your personal budget and financial obligations also play a significant role. Your pay should cover your basic needs and allow for savings and discretionary spending.
Furthermore, consider your long-term goals. If you aim to grow your business aggressively, you may need to reinvest more of your profits back into the business, which could affect your salary. On the other hand, if you prioritize financial security, your pay should reflect that. Periodically reviewing and adjusting your salary is advisable as your business evolves and your financial circumstances change.
Tax Considerations for Paying Yourself
Taxes are an unavoidable part of doing business, and your compensation method will impact how you’re taxed.
If you’re a sole proprietor or single-member LLC, your owner’s draws are not subject to payroll taxes, but they will be taxed as part of your business income. With a salary, you’ll be subject to payroll taxes, but you can deduct these payments as a business expense.
To ensure you’re complying with tax regulations and optimizing your deductions, consult with a tax professional.
The Importance of Separating Business and Personal Finances
Whether you choose owner’s draw, salary, or a combination, it’s crucial to keep your personal and business finances separate (link to this article?). This means having separate bank accounts, credit cards, and expense tracking. Not only does this make accounting easier, but it also protects your personal assets in case of legal issues.
Tips to Pay Yourself as a Small Business Owner
Managing your personal finances effectively is crucial for the success of your business. By creating a budget and sticking to it, you can avoid overspending and ensure that your business has adequate funds to operate.
Regularly reviewing your financial performance, including income, expenses, and cash flow, is essential for making informed decisions about your pay. Automating payments, such as setting up an automatic deposit for your salary or owner’s draw, can help you avoid missed payments and maintain financial discipline.
Seeking advice from professionals like an accountant and a financial advisor can also be highly beneficial. They can provide you with valuable insights and guidance to ensure that you’re making sound financial decisions for both yourself and your business. By implementing these strategies, you can gain control of your personal finances and create a solid financial foundation for your business to thrive.
Remember, paying yourself is not just about taking money out of the business; it’s about rewarding your hard work, motivating yourself, and ensuring your business’s long-term sustainability. By following these best practices and seeking professional guidance, you can establish a pay structure that supports your personal and business goals.
