As your business starts to grow, you can finally begin to cut paychecks for yourself and turn a profit as an entrepreneur. However, paying yourself isn’t always as easy as it seems.
Deciding how much to pay yourself as a small business owner is a tough decision with explicit consequences. Pay yourself too much, and you risk stunting your growth. Pay yourself too little, and your personal life can suffer.
There’s no easy answer to deciding how much you should pay yourself, but we’ll dive into what some experts say below.
Start by Calculating Your Profit
Before you can set a designated salary for yourself, you need to evaluate your current profits to understand how much money you have available. Profit is calculated by subtracting your revenue from your business expenses.
After you’ve covered the cost of materials, paid rent, issued payroll to your employees, and made payments on equipment, you can review what’s left to determine what your salary should be.
For example, if your business brings in $30,000 in a month and you have $22,000 owed to staff and other costs, then you have $8,000 in profits to work with.
Determine the Minimum You Need to Get By
Just because you have a substantial amount of profit doesn’t mean you should immediately pull those funds into your personal bank account. There are countless ways you can spend that money to benefit your business.
One way you can determine your salary is to use a cost of living calculator, which can help you map out your projected expenses and costs. For example, while you could get by on $30,000 annually in Philadelphia, you will need much more (≈ $65,000) to maintain that same lifestyle in New York City.
Map out your personal expenses and financial needs to create a base minimum income for yourself. Don’t worry—this likely isn’t what you will get paid. Your actual salary will fall between this number and your total profits.
For example, if your business has $8,000 in profits per month and you need a minimum amount of $3,000 monthly for take-home pay, then you may decide to take home closer to $4,000 or $5,000.
Identify Projects for Growth
The main reason you don’t want to pocket all of your profits: you’ll need cash to grow your business. Reinvesting profits back into your business will give you more flexibility and opportunities to capitalize on strategies to expand and scale your company.
Kyle Taylor, founder of The Penny Hoarder, follows the rule of thumb of investing half of his profits back into his business. Even in 2011, when the site was newly launched, Taylor invested $20,000 of his $55,000 in profits for a website redesign that allowed him to attract more advertisers and site visitors.
Even if you can’t afford to set aside half of your profits, at least part of your earnings should go toward the future.
Set Aside Money for a Rainy-Day Fund
If you don’t have any major project in mind—or even if you do—set aside a portion of your profits in a “rainy-day fund” for emergencies. Even if you put aside 10% of your profits each month, you can grow your fund over the year. This fund can protect you if unexpected costs or emergencies arise where you need cash and don’t have time to secure a loan from the bank.
Consider Paying Back Investors or Lenders Ahead of Schedule
The final consideration for allocating your profits is to evaluate your debt and consider working ahead to pay off your creditors. Even if you’ve already made your monthly payments back to your bank, lenders, or financial investors, consider sending more money to these organizations to pay down your debt further.
By paying off your loans faster, you can accrue less interest and will sooner reach a point where all of the company’s profits are yours. Just be careful when paying ahead: some lenders charge fees for people who pay off their loans too quickly. You could spend more in the long run because you paid off your loans in the short run.
Don’t Be Afraid to Take a Bonus
As you decide what to pay yourself, understand that you don’t have to put 100% of your funds back into your business. You don’t need to live on a ramen-noodle budget at home because all of your profits have gone to investors, future projects, and rainy-day funds. It’s OK to take a bonus when you hit growth milestones and to increase your personal paychecks over time.
Running a business is all about balance. You can’t run away with all of the profits, and you shouldn’t deprive yourself of a reasonable wage. Consider the current state of your profits and determine the best way to allocate money fairly for you and your business.