Why Small Business Owners Should Pay Themselves First

Unless you are Ms. Oprah Winfrey herself, you need to pay yourself first.

You may be familiar with her viral moments of spreading joy (as well as cash and prizes) to her audience members. “You get a paycheck! And you get a paycheck! Hey, you in the back, you get a paycheck too!” As a small business owner, that probably feels pretty familiar, except you’re not the dude in the back getting a paycheck. We’ve got a few choice words for you here: it is of paramount importance to pay yourself first. However, to pay yourself requires a degree of discipline that’s not as commonly practiced as one might think. So many companies were founded out of passion and a desire to make a positive impact in the world rather than simply for financial gain.

In the initial phase of opening our businesses, we might spend endless hours and outlay a considerable amount of cash. The idea of being that this expenditure will one day return, and hopefully in the form of ample profits (and by ample, we mean bags and bags of cold-hard cash — that you responsibly deposit into your business account). This does, however, raise the question of when it’s the right time to begin drawing a salary from your profits.

How to Pay Yourself as a Small Business Owner

Owner’s Equity Draw

This transaction is paid from the company’s accounts to your private account and will be listed in your accounting records as a withdrawal or deduction from the owner’s equity account. Ensure this is clearly and accurately recorded for tax purposes, as the law does not distinguish between business and private accounts when it comes to undeclared revenue. The potential consequences and penalties for this are severe, so keep in mind that this is not a secret party fund (although we love a good surprise party).

Dividends as the Majority or Sole Shareholder

Dividends are scheduled annual or bi-annual payments, generally paid to the company shareholders out of the profits generated–as the owner, this means you alone. This amount could be five to ten percent of the company’s profit, allowing the rest to be retained for future investment. Profits are accumulative, which means even if your business barely broke even this year, you can still access previous annual profit. Note that dividends can be paid from company profits alone — so there has to be some. Without that, there is no way of doing this legally.

Pay Yourself a Salary

Listing yourself as a company employee and drawing a monthly salary is another easy way for remuneration and keeping track of your own hours, responsibilities, and work completed in certain areas. This can also serve as a way of keeping yourself honest in terms of how much work you are actually doing. As owners, we develop a disproportionate sense of our worth in the business due to how much we have invested.

We are going to let you in on a real game-changer, ready? Pay yourself first with profits instead of revenue. Say that again. Out loud and do it proud. As you learn more about running your small business and as your company grows, you will be confronted with some hard truths and lessons. An important one, in this case, is that incoming revenue does NOT equal profit.

Calling your travel agent the minute you land a new client or services contract is not only premature, but you would be spending money based on a blurred picture of what your actual financial situation is. This can land you in a never-ending, revolving debt cycle. The first call you place should be to your trusted bookkeeper or accountancy service providers to see how your books are doing. *waves hello vigorously*

Whichever method you use to pay yourself with, as the business owner, remember that these payments come from profit and not revenue, which could be easily confused if you look at the amount in your company’s bank account. Ensure that all your expenses are comfortably covered before you go out ballin’ and paint the town in vivid rainbow colors.

BTW, if you haven’t yet read Profit First by Mike Michalowicz, you should grab a copy as soon as you finish reading this post. It’s a great read that makes it easy to understand how your profit — not revenue — determines the success of your company. We can’t recommend it highly enough!

Cashflow Assessment

So, you might be wondering, how do I make my own vegan ricotta? Although that sounds delicious, we can’t quite help with that. However, if you are wondering how to ensure your business turns a profit, we’ve got you covered. You need to develop a way of accurately forecasting your company’s cash flow based on the analysis of accurate financial reports — monthly, quarterly, annually, or all the above if you’re aiming to be thorough. This projection’s accuracy is essential, as this will determine where you are regarding your incoming and outgoing invoices, overheads, contracts, and any additional expenses or revenue.

Once you have developed a clear-cut, realistic relationship between your turnover and how it actually reflects in your cash flow statement, you can then safely look into your profits and which way is best suited to pay yourself within your business model. You may need to enlist the services of an outside accounting firm for this, *peeks out from bushes* as tackling this alone can be daunting as well as time-consuming.

Consider the Rules and Regulations

In the initial and foundational phase of your business, you need to decide which path you wish to follow in terms of your company’s legal infrastructure (staying within the confines of the law is a great start). This means choosing between setting up a closed corporation, an LLC, a partnership, or simply a sole proprietorship. The method you use to pay yourself is directly affected by the way in which you have structured your company legally. For instance, as a corporation owner, you can pay reduced taxes on your profits by drawing an inflated monthly salary. However, your salary amount should still be proportionate to those of your employees and scrupulously justified, unless you fancy a visit from tax authorities.

Whether you are just starting up or an already thriving business entity, you would do well to seek legal and tax advice on these matters. The experts can advise you on the best way to structure your company and which method of paying yourself best suits this system as a small business owner.

Pay Yourself on The Regular

You work hard; you deserve to get paid. Drawing a monthly salary as CEO or head of your company will provide you with regular income. However, if you are drawing from your owner’s equity share, you will need to set up a consistent schedule for these payments. The amounts may vary, as they are dependent on your profits. But it is still essential to keep them as uniform as possible so you are able to budget, plan and make necessary financial projections.

Not only is the regularity of these payments of greater personal financial benefit to you, but they are easier to track on your accounting records. Besides, you won’t look like much of a team player in the eyes of your employees if you are constantly dipping into your company account at will. Strictly following policies regarding these payments and their amounts project good optics and create an ethically sound work environment.

Which Way to Pay Yourself, and How Much?

In a small business operation, there are various ways to go about paying yourself regularly and with utter surety. Assessing market value by looking at similar-sized companies within your particular industry is an excellent place to start. Ensure that you always take into account the regional and economic factors when comparing companies. The owner of an advertising agency in Sao Paulo may earn a different level of income to one based in Dubai, for instance. Even locally, there can be substantial economic disparity within some cities or states, and it may be of benefit for you to understand why.

Paying yourself a fixed percentage of company profits is also a viable option, and the amount needn’t fluctuate either. Instead, simply use your annual cash flow projections and set the amount based on your yearly estimated profits. When selecting this amount, remember that every company needs room to grow — and this room is afforded by liquidity. Be sure to retain enough of your profits to compensate for any market fluctuations or unpredictability you may encounter over the course of the year.

Put Your Employees First

Yes, in the challenging moments where you need to decide who earns what, your organization’s stability rests on your employees and their job security. You must see an employee’s salary as a simple cost of running your business and never compare it to how much you are earning as the owner. You must be flexible enough to pay yourself earnings dependent on your business’s financial ups and downs and use this process to inspire your success as a business owner.

However, this is specific to critical financial situations that arise in the timeline of running your company, and hopefully, they are temporary states of affairs. Accumulating personal income is still a priority, whether times are good or not, so try to keep this a regular part of your running costs.

We think you are royalty and deserve to be treated like the king/queen/both that you are. You can start to pay yourself with something small — less than a percent of your annual profits is a healthy practice that you can build into your small business as it grows. Now that you are more familiar, you can also see just how important it is to pay yourself first as a business owner. Not just because we love you, but because it’s crucial to building a better business.

As a leader, those around you will r-e-s-p-e-c-t your strength and flexibility when the going gets rough. And don’t forget, you’ve got your friends at Alchemy Accounting to share the load. *picks up your load and throws it in the trunk of your vehicle with the strength of 1,000 Hercules* We do whatever it takes to ensure your financial decisions are based on accurate info and advice. Because we’re good like that.