If you're one of the tens of thousands of contractors who has to not only work on your business but also in it, how do you determine what your salary should be?
If you’re a sole proprietor with no employees and very little business overhead, what you pay yourself is pretty much what you earn in sales minus your costs and taxes. But what happens when your business grows and you take on employees? How do you determine what your salary should be when you are not only operating in the daily grind of your business, but are also spending considerable time selling, planning, training and just managing?
As a business owner, setting your own salary can be a tricky task, especially in markets that see highs and lows. Here are a few tips to help you determine the best way to "pay the boss.”
No magic formula
There is no magic formula for setting your salary because so much depends on the development stage of your business and how it’s doing. For example, if your business is still in a startup phase, your salary may still be essentially what’s left over after your operating costs and bills have been paid—and this may not be a lot.
On the other hand, if your business has shown consistent profit, then you should feel free to take a percentage of those profits, or set a salary for yourself in accordance with industry and regional standards.
How your business is legally structured also impacts your compensation. Talk to an accountant or tax attorney about the best options for you, because overpaying yourself can raise red flags with the IRS. For example, if you operate a corporation, avoid taking too great a percentage of total revenue as your salary. Your accountant can help you determine what’s reasonable.
Above all, be prepared to be flexible and accept that you may need to be flexible during down times or when cash flow is tight. And remember that you’re not an employee; your primary focus should be on the long-term growth of your business, not your paycheck.
How to set a salary as a percentage of profits
It’s hard to forecast your profits for an entire year, so if you’ve been in business a few years, review your past performance and use it as a benchmark. Determine what an appropriate percentage of that figure would be after factoring in your business costs, taxes and future growth plans, and set that as your tentative salary. Most small businesses limit their salary to 50% of profits.
If you are still in startup mode and have no profit history or aren’t turning a profit yet, you might want to set your salary by reviewing your own personal costs. What do you need to support your modest, startup lifestyle? Defer everything above and beyond that.
Check out the competition
One standard practice is knowing the average income for your industry, field or peers. Take a look at SBA.gov’s Income Statistics resources for information on income and earnings across a variety of occupations. Don’t forget to factor in regional variations. And remember, you may not be able to pay yourself an equivalent salary yet, but you should know the average.
Factor in employee pay and what you give your business
Remember that the time you invest in your business may vary considerably from the hours of your key employees. And while you don’t want to overpay yourself, don’t limit your salary because you feel that your hourly earnings are more than your number-two employee. This is your business, after all, and while you may be investing 50 hours one week, you may put in 65 the next. So your salary needs to reflect the elasticity of your time investment. So if you’re using your hourly commitment to help determine your pay, make sure you account for the extra hours when you do your calculations.
Even if you don’t have an accountant on retainer, seeking the counsel of an accountant to review your figures will help you factor all the variables that help determine your salary. These may include taxes, employees, operating costs, loans, personal costs, marketing and growth plans. Accountants, or even lenders, also can help you make related decisions about how to manage your profits. For example, it can be tempting to pay off loan financing as soon as you turn a profit. This, however, will reduce what you take as a salary and could affect your lifestyle.
Organizations such as SCORE, Small Business Development Centers, Women’s Business Centers and more are available to help advise small-business owners on all aspects of running a business, which includes managing finances and paying the boss.