8 Rules for Setting Your Salary as a Small Business Owner

Guest Post by National Funding

It’s one of the trickiest questions facing every small business owner — how much do you pay yourself? On the one hand, you don’t want to put the business in jeopardy by setting aside too much salary for yourself. On the other hand, you don’t want to penny pinch unnecessarily. After all, you start a business to make money, not to live as frugally as possible.

Finding the balance between too much salary and too little doesn’t look the same for everyone. What could be too much for one small business owner could be too little for another based on their industry, location or time in business.
The right salary for you is based on your financial needs weighted equally against the needs of your business. The total could also change unexpectedly if financial conditions change. Ultimately, the only way to find the right figure is to evaluate it over and over again. Use these rules to help you calculate correctly:

1. Keep finances separate

Before tackling the question of your salary, you need to separate your personal and business finances. Create a separate business bank account and consider applying for a business credit card. Not only does this create a wall between your finances, it also allows you to build business credit, which helps with securing small business loans or equipment financing. Get in the practice of keeping your finances strictly separate so that your final compensation is transparent.

2. Commit to compensation

In some cases, you may not want or need to draw a salary. It’s always better to take some kind of compensation because it signals you have a financial connection to the business — when it succeeds you succeed. Demonstrating that connection is an important signal for employees, investors, financers, and tax collectors. They want to see that you’re committed to a business rather than pursuing a hobby.

3. Consider all options

Salary is just one component of compensation. It can also include benefits, stocks, bonuses, or a commission structure. There are multiple ways to take compensation from your company — for instance, extensive benefits may serve your needs better than a large salary. Another option would be to set your salary as a percentage of profits so your compensation is tied to performance. The important takeaway here is that how you decide to collect your compensation will affect your business and personal finances. As you’re investigating how much you need to earn, also consider how different compensation structures will impact both your business savings and your lifestyle.

4. Obey the IRS

Small business owners can pay themselves in one of two ways. Either option may be appropriate, but it’s important to understand the tax consequences of both:

• Salary Method — you pay yourself as an employee of the business. As such, withholdings for Social Security, Medicare, and all your income taxes are taken out before you’re paid.
• Owner Draw Method — you withdraw money from your business profits. Nothing is withheld from these withdrawals, meaning you’ll be responsible for paying all federal and state taxes owed on your own.

5. Pick your payday

When you get paid matters for both you and your business. If you’re drawing a salary, it makes sense to pay yourself on the same schedule as other employees — usually every two weeks. If you’re going with the owner-draw method, plan to make withdrawals on a set schedule and document your actions thoroughly for tax purposes.

6. Don’t neglect investments

When the business is doing well it is easy (and often appropriate) to reward yourself with a higher salary. Just keep in mind that employees want raises as well. It’s also important to be regularly investing money back into your own business. It helps relieve your tax burden while also making it easier to get various kinds of small business financing. You shouldn't feel discouraged from raising your wages, but you should consider everything else that money could go to as well.

7. Calculate reasonable compensation

At some point you have to put a dollar amount on your salary. According to one survey, the average small business owner salary is $59,000, but that doesn’t account for factors like the size or location of the business. Start by calculating how much you need to make to cover all your fixed expenses. Ideally, this is your minimum salary. You can also estimate an appropriate figure by using salary tracking tools to find out what professionals with similar skills are making in your same area. If that approach doesn’t work, think about how much you would pay to outsource everything you do for your business.

8. Study the financials

You can only pay yourself as much as the business can afford. When thinking about how to set your salary, the best way to inform this decision is to understand your business’s cash flow and predict your profitability. Account first for business expenses and profit taxes so you have an idea of what income is available for your salary. Beyond looking at your business’ current financial picture, you also should factor in any future growth plans. For instance, if you plan to open a new location, drawing a sizable salary may cut into your working capital. If the bottom line makes it impossible to earn as much as you need, consider raising your prices or financing a growth opportunity.

There is no magic formula for calculating your salary. However, if you follow all of these rules you can feel confident you’re making informed decisions for yourself and your business. And no matter what you end up making, remember one important thing — you’ve earned it.

The Bottom Line is a blog from the experts at National Funding, a leading source for small business loans and equipment financing solutions. We show entrepreneurs of all stripes how to resolve cash flow issues and seize growth opportunities. Check in to The Bottom Line regularly to find advice and insights to help you sustain success, and rely on the resources of National Funding if your business ever needs affordable and accessible lending options.