For entrepreneurs, the financial freedom of being your own boss and determining your own pay attracts many to become business owners. However, in the process of setting up and growing the business, one loses track of one’s own income and mixes business and personal finances. This is neither healthy nor sustainable, as business financial needs will never end and will ultimately hurt your personal finances. Determining your salary can be a discipline and a balance between business and personal finances.

But how much should you pay yourself? That is the question that has no straight answer.

Why Should Entrepreneurs Pay Themselves?

When you are a sole proprietor, you can simply draw your profits from the business, and that will be your income. As you are the only employee and the sole owner of all profits, things are simple. However, when this setup changes, you have to determine how to pay for yourself.

Change in Business Structure: If your business is growing and you are considering introducing a business partner or securing private equity funding, you will no longer have 100% equity ownership. It means the investor or business partner will have a share in the profit or loss, creating the need for a fixed pay for yourself.

Have Stable Personal Finance: If your business is not growing and one reason for it is your excess withdrawals, you need to determine a salary for yourself. A fixed regular payment will regulate withdrawals from the business and also control your personal spending. This will leave you with enough cash to reinvest in the business and grow while strengthening your personal finances.

How Much Salary Should You Pay Yourself?

As you are your own boss, the decision is yours on how much you want to pay yourself. But you are also a business owner, and business owners don’t make decisions based on emotions but on real-time data.

The salary you pay yourself should be reasonable, meet the industry standards, and be something your business can sustain. A business that earns an annual profit of $80,000 cannot pay its business owner an annual salary of $100,000, even if the industry standards for a CEO are $100,000 for a business of your scale.

The key is to customize and balance profits and the pay of entrepreneurs. Remember, even businesses that make a loss in a particular year pay their employees. When calculating your salary, you have to take into consideration:

• Your fixed and variable expenses, like rent, utility bills, maintenance, raw materials, and other costs needed to generate sales.
• Identify the minimum revenue your business earns and determine the breakeven point.
• Look at the annual profit your business earns and how much profit it can sustain when sales are slow.

The amount left can serve as the basis for determining your salary. You can have a variable and a fixed component in your pay, with the fixed component growing with inflation but the variable component tied to business profits.

For instance, Michael runs a retail store and earns a minimum monthly profit of $7,000. He decides to give himself 50% of the profit as salary. The bonus can vary depending on any surplus he earns above $7,000. If the overall business grows sustainably and the minimum profit increases to $10,000, Michael’s salary will increase as well. In a given month or year, if the business incurs a loss, the retained funds can be used to pay the fixed entrepreneur’s salary of $3,500 per month.

This is an ideal scenario where a business is expected to make reasonable profits. However, startups may not be profitable in their initial years. That’s where forecasting and business goals come into the picture. As a business owner, you can set a target to achieve breakeven in x years and earn 5%, 10%, or 20% profits in x years.

If you achieve your business goal, you can reward yourself with a higher salary, thereby aligning your business goals with personal finance goals. This self-pay can motivate you to grow your business efficiently. Gradually, you can reach a point where your salary is competitive and does not hurt business growth. Time and again, entrepreneurs should evaluate their salaries and align them with business needs.

How to Structure Your Pay

As an entrepreneur, your compensation should reflect the company’s financial status and your contribution to its success.

Use the Industry Average as the Base: Start by knowing the average salary in your city and industry. The government maintains data on baseline salaries for large and small businesses. You can also check with the trade associations in your area or look at what competitors are paying themselves.

Know the Economic Value of Your Skills: Your salary is based on your skills and experience. While the average salary might give you a fair idea, knowing the market value of your skill can help you set a benchmark. Suppose you are a graphic designer and someone of your skill can earn $60,000–$64,000 per year or $30-$33 per hour in an organization as an employee. You can aim to earn this amount from your business over time.

Flexible Salary Structure: Once you have set your benchmark, it is time to design your salary structure. The key is to make it flexible and aligned to your business, personal goals, and financial realities. You could consider the following tips:

Your salary could be a percentage of your profit. This way, you can retain some profit in the business to create an emergency reserve and reinvest in growth and expansion. For instance, instead of taking out all the profit and rewarding yourself with a luxury vacation, you can spend that money on marketing to bring new customers and increase revenue.

You can also consider paying for the hours you have put into the business that are generating revenue. This can help you stay disciplined and avoid overpaying yourself. You reap the benefit of your direct contribution. Some days you might work fewer hours, and some days more. Lawyers and consultants use an hourly basis to determine their pay.

As an entrepreneur, you have the right to be paid for your contributions. However, determining a reasonable and sustainable salary is complex and should be reviewed regularly.

Contact Ford Keast LLP in London to Help You Design a Robust Compensation Structure

A professional accountant can help you crunch the numbers and identify the optimal compensation structure. At Ford Keast LLP, our accountants and advisors can provide services such as filing your personal and corporate tax returns accurately and planning tax-saving strategies. To learn more about how Ford Keast LLP can provide you with the best accounting and advisory services, contact us online or call us at 519-679-9330.