When you invest time, resources, and energy into your business, it’s reasonable to be compensated in return. But determining when, how, and in what contexts you should receive a paycheck are another matter. There isn’t a lot of clear guidance on what to do, and it can be a confusing process to set a salary that’s fair, predictable, and sustainable.
In this article, we’ll help you work through this topic and find answers to your salary questions.
With the income I’m generating, am I able to pay myself?
This question is one of the first you should ask when setting up your pay. To answer it, you’ll need to take stock of the following factors:
Is my business covering its operating expenses?
Before paying yourself, take time to verify that your business has enough cash on hand to cover its expenses.
The net income you reported in your financials will provide you with an answer to this question. You’ll need to look at your most recent profit-and-loss statement (run it from your bookkeeping solution or create it with a template like this one), and you may also want to look back at your previous profit-and-loss statements, too, to ensure you have—and have had—more than enough on hand to cover regular, recurring costs and impending expenses.
Does the business have enough cash on hand to cover tax obligations?
If your business makes a profit, it will likely have tax responsibilities to meet at the federal, state, and local levels. Those obligations must be met. But how much you need to set aside depends on a number of factors, including how you’ve structured your business and the area in which your business is located.
Many experts advise setting aside at least 30 percent of your net income for taxes before spending or distributing what remains, but an accountant can help you determine your true tax obligations.
You can connect with an accountant knowledgeable in tax law at any of these firms:
Is the business covering its debt payments?
Tally up your loan, lines of credit, credit card debts, and any other obligations that have a minimum monthly payment. It’s important that you have at least enough cash on hand to cover what’s required, and ideally, enough to apply extra against your debts, before considering a salary.
Does my business have enough savings on hand to cover a few months of expenses?
Business expenses such as rent, utilities, and wages are relatively stable and predictable from month to month, so looking ahead to upcoming expenses and determining if you can cover them should be a relatively simple task. However, make sure that you also have enough set aside to cover some emergencies to occur and the costs of growing your business.
Here, a fractional CFO can be a great resource. You can contract with a financial expert for a few hours each week or month to help you create financial plans and make calls that will improve the financial well-being of your business.
Would you like to connect with a fractional CFO? Take a look at a few of our favorite firms:
Refer back to the four questions we just shared. If you can answer “yes” to each of these questions, you’ll likely have enough on hand to begin collecting a regular salary.
How much should I pay myself?
If your business can afford to pay you a salary, find out the maximum amount you can take without creating more debt. In most cases, that amount is the absolute ceiling you should place on your salary. However, it’s not necessarily the number you should commit to.
Instead, look through your own expenses and set a livable salary. Make sure you can cover your costs and have enough left over to experience some comfort.
If your livable salary is within the range of what your business can pay, proceed with confidence. You can always change it later after ensuring your business can cover the cost long-term.
But, if your livable salary exceeds what your business can pay, you’ll have some work to do before proceeding. Take on these two tasks:
- See if you can cut your personal expenses to work within the salary your business can offer today.
- Review your business expenses and trim some fat to free up additional cash.
Should I pay myself differently as my business grows?
Many advise owners of maturing businesses another strategy: You can determine what you’re worth by setting and holding your business to a fair hourly rate rather than what you need to earn to get by. Keep in mind that the rate should be reasonable for your business and one it can afford to cover over the long term.
How do I factor tax and legal considerations against my salary?
Sometimes, you’ll need to work within other constraints when setting up your salary. The structure of your business is one of those constraints.
If your business is organized as a sole proprietorship, you can claim whatever salary you believe is fair and sustainable without looking to others for guidance.
However, if you have partners or shareholders, you’ll need to account for others’ views of what’s reasonable. You can rely on industry salary guidelines, geographic salary information, and job title payroll data to find some precedence for a fair salary.
Taxes might not constrain what you can take, but tax law can help you choose paths that benefit you or your business in a given year. For example, rather than taking a straight, simple salary, you and a tax advisor could explore the following options:
- If you own stock in your business, you could pair a modest salary with dividend payments from your shares.
- You could pay yourself entirely through stock or stock options.
- You could award yourself carefully timed bonuses to create favorable tax scenarios.
Would you like to connect with an accountant who can help you with tax strategies? Check out some of our favorite firms here.
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