Posted in Payroll | by: Andi Smiles

Dear Business Owners: You’re Thinking About Your Salary All Wrong

We partnered with small business financial consultant Andi Smiles to help our readers build healthier relationships with their money. Ask Andi your deepest, darkest money questions here in her Facebook group.

 

I still remember the day I got my first paycheck from my after school job. I immediately went to the bank, cashed it, and headed straight to the mall.

There was something so rad about getting a piece of paper that magically turned into cash that magically turned into an epic feast at the food court.

Getting a paycheck is SUPER rewarding. Yet, some small business owners don’t get the reward of a steady paycheck. Instead, we get the frustration of figuring out how to divvy up our money between our business and personal finances.

But you can climb out of the salary fog. Here’s my holistic method for calculating owner pay, along with a free spreadsheet that will help you land on the best salary number for your situation.

Free business owner salary calculator.

Take it for a spin ↓

Small business owner salary calculator

Seriously, how much should I pay myself?

The number one question I get asked when it comes to owner pay is,

  • “What percentage of my income should go towards paying myself?”

The truth is, when it comes to owner pay, there’s no one-size fits all formula for how much you should pay yourself.

Subscribing to percentage-based owner pay formulas without taking into account the unique landscapes of our lives and businesses can cause financial imbalances. It’s like going to the doctor with an illness and being given a pill before you even describe your symptoms. It’s a shot in the dark.

Maybe you’ll get lucky and it’ll work… or maybe it won’t and you’ll get sicker. 🙁

The first step to figuring out your salary is to ditch the percentages and rigid rules about how much money goes where. Instead of thinking of owner pay as a formula, think of it a holistic method that addresses all aspects of your business finances.

Each of these things should factor into how much you pay yourself:

  • Covering your operating expenses
  • Saving for taxes
  • Paying off debt, and
  • Building your business savings

My six-step method will help you think about all of the above. Now, open up that spreadsheet and let’s begin.

Step 1: Start with calculating your monthly net income.

This is the foundation of your owner pay.

We start with our net income to ensure that our business can cover its expenses first. If you randomly take money out of your business without planning for your expenses, you’ll be boarding a plane to Debtsville fast.

Net income (aka profit) is what’s left after you subtract your business expenses from your gross revenue (all the revenue that comes into your business).

The formula for net income is:

Gross revenue – Expenses = Net Income

You can easily find your monthly net income by running a Profit & Loss report for a monthly period from your bookkeeping program. I like using the average net income of the previous six months to be sure that I’m accounting for quarterly and unexpected expenses.

Step 2: Calculate your tax savings.

The next step is to figure out how much you should save for taxes.

Real talk—saving enough for taxes is one of the biggest challenges small business owners face. Why? Because most people think about saving for taxes AFTER they pay themselves, pay off their loans, and invest in that fancy new office chair.

Here’s the thing—if your business makes a profit, you’re going to pay taxes. Saving for taxes is a non-negotiable part of your business finances, which is why it’s the second step in this process.

How much should you save for taxes?

A safe starting point is 30 percent of your net income. So if your net income is $100,000, you should put aside $30,000.

If you’re in a higher tax bracket or filing jointly with someone with a high income, your tax savings percentage may be higher.

If you have an accountant or tax preparer, ask them what percentage of your net income you should save for taxes. Since they’ll know your unique tax situation, they can give you a more accurate percentage. But if you’re a new business, start with that 30 percent.

For owner pay, you’ll subtract your monthly tax savings from your net income number. This will be what you the owner has access to personally, or in other words, your owner access number:

Net Income * 30% = Monthly Tax Savings
Net Income – Monthly Tax Savings = Owner Access

Step 3: Factor in your business debt.

Now you get to pay yourself, right? Wrong! Now you get to pay off your business debt. (You’ll thank me later.)

For this step, start with the total amount of your monthly minimum debt payments. If you’ve borrowed money, your lender requires you to make a minimum payment each month. Add up your minimum monthly payments for each loan or credit card. Later, at the end of the process, you can increase your payments if you have extra money left after paying yourself.

And keep in mind that your loan interest is tax deductible.

Now, subtract your monthly minimum debt payments from your owner access number from step two:

Owner Access (from step two) – Monthly Debt Payments = Owner Access

Step 4: Create a business savings plan.

Are you planning to make a major investment in your business in the next few years? Thinking of creating a business emergency fund? Or building a healthy cushion into your checking account?

Before you pay yourself, consider how much savings you want to have in your business—not your personal accounts.

Businesses typically save for:

  • New hires
  • Equipment purchases
  • Product development
  • Product launches
  • Checking account cushion
  • Rebrands or website redesigns
  • Training programs or certifications
  • Emergency funds (which are three to six months of expenses)

When planning your business savings, go through the following exercise:

  1. Refer to the list above and see what stands out to you. What are you saving for? (Hint: make a list like the one above)
  2. Answer these two questions. How much do you want to save for each item on your list? How many months will it take you to reach this goal?
  3. Rewrite your list in order of priority. What are your totally committed to saving for? What are you willing to wait on?

Based on your list, pick a few of your top priorities and divide your savings goal by the number of months it will take you.

This is your monthly savings amount for each item:

Savings Goal / Number of Months = Monthly Savings Amount

Next, add up your monthly savings amounts for each item. This is your total monthly savings.

Then subtract your total monthly savings amount from your owner access number from step three. This is your final owner access number.

Owner Access (from step three) – Total Monthly Savings = Owner Access

Step 5: Get real about your personal needs.

You finally know how much you have available to pay yourself! Is it enough? That’s what we’re going to find out.

Forget about your owner access number and look critically at your personal needs. How much do you absolutely need your business to pay you? Everyone’s answer is going to be different. If you’re the primary financial provider in your family, you’ll need more. If there’s another source of income in your life, you’ll need less.

If you’ve never done an in-depth analysis of your personal finances, now is a good time to review your:

  • Fixed expenses: These are necessary living expenses that don’t change from month to month, like your rent or mortgage.
  • Variable expenses: These are necessary living expenses that fluctuate month to month, like your groceries.
  • Extra expenses: These are fixed or variable expenses that are not essential for you to live, like cable TV or eating out.

How many of these expenses do you need your business to cover? What can you go without while your business builds momentum? Use these questions to figure out your monthly personal need number.

Step 6: Finesse the numbers.

In an ideal world, your personal need number is less than your owner access number from step five. In that case, get down and pay your bad self!

But, more likely, your personal need number is more than your owner access number. This is where you finesse the numbers.

Before you do, get clear about your priorities in your personal life and business. Out of the following, which are you willing to change?

  • Business expenses
  • Debt payments
  • Business savings
  • Personal need expenses

Notice how tax savings isn’t in there? That’s because taxes are still a non-negotiable.

Start with the numbers that are least important to you. For example, if saving for an office remodel is more important to you than eating out, cut down your personal need number (and extra expenses). If saving for your kid’s birthday-palooza is more important than saving for a work laptop, cut down your business savings.

The goal is to get your owner access number to match, or be greater than, your personal need number.

Or in other words, you want the amount of money you can access to be more than how much you need. Tough decisions will have to be made. You might need to cut down in all of the areas to make it work. That’s okay. Remember, we’re coming up with a sustainable owner pay number, not a fantasy that is completely unrealistic for your lifestyle and business.

If your owner access number is more than your personal need number, reallocate the remainder.

  • Will it stay in your checking account to build your cushion?
  • Go to increased savings?
  • Help you pay off more debt?
  • Or be more money towards your owner pay?

Knowing your priorities ahead of time will make it easier for you to decide what to do with the surplus.

___________

Ready to set a salary you can stick to? Now you can give yourself that same magical feeling that comes from seeing your hard work turn into a paycheck that turns into cash—that turns into something meaningful for you and your business.

Once you know how much to pay yourself, use Gusto to make the process even easier. See how.

How much should a small business owner make? Here’s my holistic method for calculating owner pay, along with a free salary calculator.

 

The opinions expressed in this article are those of the author and do not necessarily represent Gusto’s views.

This article provides general information and shouldn’t be construed as tax advice. Since tax rules may change over time and can vary by location and industry, it’s always best to consult a CPA or tax advisor for advice specific to your business.