One of the many decisions you have to make when running your own business is how to pay yourself. It is a crucial question worth asking right from that start as it will ensure your company’s finances are organized, while helping ascertain your personal needs are met. You cannot take this decision lightly as it will have a huge impact on your business’s financial health, including your personal finance, especially when you pay taxes. Treating your revenues like an ATM can wreak havoc in your cash flow, confusing your ledgers. Thus, you must carefully incorporate your own salary into your business plans. Let’s dive deep to see the steps need so you can properly reward yourself with the right compensation package.
The Process of Paying Yourself as the Boss
First of all, a few factors help determine your pay. It includes the kind of business entity you have, your company’s profits, and the value you add. These factors will help you understand whether to pay yourself via salary or draw.
1. Determine the Type of Business
The structure of your business has a significant impact on how you pay yourself. Your business entity will influence how you receive your wages, how you file taxes, and how much dues you owe to the BIR. When starting any business, there are several structures to choose from. Let’s take a look at them below and see how they can affect your compensation package.
Sole proprietorship:
As the name implies, you are the sole owner of the business. Many opt for this structure as it is the easiest to set up. Noteworthy, you and the business are treated as the same entity. Hence, you can receive all the profits, but you also hold responsibility for all the losses and liabilities incurred. With this structure, you can either be paid via salary or drawings.
You choose to pay yourself a salary or a fixed amount taken regularly from the business with the corresponding withholding taxes. This amount is based on reasonable compensation for whatever work you perform for your business. Think of your title and geographical location, then assess how much you will earn if you get a job in a different company with the same job title and responsibilities. After finding out the figure, pay yourself the same salary. An advantage of this is you have an expected monetary figure you can use for personal expenses every month.
On the other hand, as the sole proprietor, you have the power to pay yourself whatever you want by cutting yourself a check from your business account. This is called an owner’s draw. Whatever you withdraw is not a salary but merely money from profit. As such, these draws aren’t taxed when you take them out. Therefore, you must be prepared to pay taxes on these draws when you file your individual tax returns.
In the draw payment style, you can take only enough to keep your company rolling. On that note, there are a few things to keep in mind:
- Only take a draw from the capital previously invested or the profits
When you suddenly get a large influx of cash in your business, it is tempting to draw a considerable amount for yourself too. But that could mean putting your business at risk, being unable to cover your future expenses. It is best to keep your draws at a consistent size.
- Learn about related taxes to factor in your payment
Having a business means paying taxes. Therefore, you have to factor in the taxes you have to pay before determining the amount you can draw from your company. It means you will have to take out about 30 to 50% of your net profit before you can compensate yourself.
Partnership:
A partnership means you and at least one other individual own the business. In this scenario, all the partners share the profits and losses incurred. Therefore, the amount you will receive depends on how much ownership you have as outline in the partnership agreement. In the same token, you are also taxed according to your respective income. Furthermore, this income is subjected to graduate income tax scale for individuals.
Corporation:
If you own a corporation, you own a separate legal entity. This means your personal assets are separate from your business. Thus the profits and liabilities are separate from your personal finances. You can get your payment through salary or dividends, which you must declare for your individual income tax. Notably, though your personal properties are protected from losses, you are also taxed twice because you pay a separate corporate tax.
2. Factor in Your Profits
The amount you pay yourself can also depend on how much profits is coming into your business. When you know how much profits you make, you can set a reasonable wage for all your efforts. Of course, you want something that can pay your personal expenses, while leaving sufficient funds to cover your business bills. During lean months, you can opt for lower wages.
It would help to make a business budget, where you factor in revenues and expenses. In your spreadsheet, you must include your salary. Do note, the more profit you have, the more salary you can pay yourself. Usually, how many years you’ve been in business can influence your salary, too. Typically, startups may earn less income as the birthing pains can have huge costs and more losses. However, as the business stabilizes, you can expect higher returns.
3. Assess How Much Value You Add
Since this is your business, you put in a lot of time and your best effort into making sure things run smoothly. Chances are, you work more than your employees, so you may feel that you need to pay yourself more. Knowing how much value you add to your business can help you determine your wages. It will help if you compare the figure with other entrepreneurs in the same niche. Knowing the industry averages can help you make a concrete choice if you feel unsure. In general, you must remember that most entrepreneurs stick to 30% to 50% of the profits.
4. Think of Your Personal Expenses
Finally, you must think of a wage amount that covers your personal expenses. Just like every entrepreneur, you want your business to grow, but make sure this doesn’t happen at the expense of your comfort. Ensure you have enough funds to cover your home rent or mortgage, food, utilities, and the like. It would be wise to leave yourself a little extra for an emergency fund to cover unexpected expenses.
Top Tips to Remember
Paying yourself requires harmony and balance between keeping your business growing and addressing yours personal needs. Most business owners struggle with this initially. To help you out, remember these top tips:
- Consider what kind of business entity you have, as the structure can affect how you pay yourself.
- Make sure you give yourself enough money to live a comfy lifestyle.
- Enforce a budget so you can account for everything and pay all bills on time.
- Resist the urge to overpay yourself, especially during the lean months.
- Mark your salary in your accounting ledgers and file the proper taxes to avoid arrears, penalties, and surcharges.
Final Wrap Up
Now you know how to pay yourself when you’re the boss. Still, it is best to talk with your accountant about this before finalizing your decision. They can teach you more about how much you can allot for yourself as the boss without jeopardizing your business’s success.
Want to learn more about how to pay yourself when you’re the boss? Talk to us. We’d be glad to answer your questions. Book a free 30-minute consultation with us today!
