A question many small business owners have vis-à-vis profitability is how much they should be paying themselves. When figuring out how much to pay yourself, the most important thing to consider is your business’ financial condition. Before you can decide how much money you can safely pull out of the business each month, you need to first figure out how much money your small business needs, because its needs come first.
So you need to calculate your break-even point and go from there. Knowing how much comes in and goes out allows you to figure out how much you can realistically afford to pay yourself. How much is that? Only you can say for sure after seeing your budget, but as you begin to formulate that number, keep the following three things in mind:
1. Your business structure often determines when, and how, to pay yourself. As I have written here recently, are five forms your business can take: C corporation, S corporation, limited liability company (LLC), partnership, or sole proprietorship.
Only owners who have set their businesses up as C corporations are legally considered "employees" of the business. If your business is a C corporation, then you can pay yourself as you would every other employee - as part of normal payroll.
Many small businesses start their businesses as sole proprietorships or partnerships. Sole proprietors can pay themselves whatever they want; it depends almost entirely on how much profit you make, how much money your business needs, and thus what you can afford to pay yourself. Partners must consider the desires of each other when determining how much they will be paid.
The same is true for LLCs that have more than one owner, with one caveat: You can make a distribution of profits legally, only if doing so does not impair the solvency of the business.
2. Avoid paying yourself as the money comes in. Many small business owners make this mistake. If they have a good month, they take the extra out of the business, if they have a bad month, they don’t. It is imperative that your business checking account always has enough of money in it so that if something goes wrong, you can afford to fix it.
If you pay yourself whatever comes in every month, saving for a rainy day will be impossible. The smarter thing to do then is to come up with a figure to pay yourself that your business can live with, and pay that amount to yourself on a consistent basis.
3. Consider the tax consequences. If you have a C corporation, when you pay yourself, the business is responsible for payroll taxes on the amount you get paid.
In the case of a sole proprietor and partnership, whatever profits the business makes "flows through" onto your personal income tax - your business' profits or losses are considered your personal profits or losses. Partners and sole proprietors are also responsible for the self-employment tax, which runs about 15 percent. Remaining profitable takes constant attention to detail. Keeping track of your margins and then increasing business or reducing costs as necessary is what is required.