How to Calculate Your Salary as a Small Business Owner
by Fundid on Sep 20, 2023 8:00:00 AM
Are you a small business owner wondering how best to pay yourself? With so many factors to consider—such as taxes, ongoing expenses, and unexpected costs—calculating your salary can seem like an overwhelming task. But never fear: by following these simple steps, you’ll be able to determine the right amount of compensation for all your hard work while ensuring your business stays on track financially.
Step 1: Know Your Business Revenue
Before you set a salary for yourself, it's important to understand your business's overall financial situation. The first step is determining your total revenue for the current fiscal year. Revenue includes all income generated by sales and services, plus other sources such as grants and investments. Once you know the exact dollar amount of your annual revenues, you can move on to step two.
For this example, let's say your total annual business revenue is $500,000.
Step 2: Calculate Your Business Expenses
Next, calculate all your business expenses, including operational costs, taxes, employee salaries, and reinvestment. Using expense management software like Divvy, can be helpful when keeping track of your business expenses because the software automatically categorizes your spending into helpful reports.
Common Business Expenses:
- Rent and Utilities: These include the cost of your physical location and utilities like electricity, water, and internet.
- Salaries and Wages: This includes the salaries of your employees, plus benefits and payroll taxes.
- Inventory and Supplies: If you sell physical goods, these costs include purchasing inventory. For service-based businesses, this could refer to necessary supplies.
- Marketing and Advertising: Costs related to promoting your business, such as social media ads, print advertisements, or hiring a marketing agency.
- Insurance: This includes general liability insurance, professional liability insurance, and workers' compensation insurance.
- Professional Services: Fees paid to lawyers, accountants, consultants, etc.
- Taxes: Depending on your business structure, you could be liable for various taxes like income tax, sales tax, and property tax.
- Equipment and Technology: If your business requires specific machinery or technology, these are considered expenses.
- Maintenance and Repairs: The cost of maintaining and repairing your business facilities or equipment.
- Travel Expenses: If your business requires travel, you'll need to account for airfare, lodging, meals, and other related costs
For this example, let's say your total business expenses are $300,000.
Step 3: Understand Your Personal Living Expenses
Before you determine your salary, it's essential to understand what your personal living expenses are. These include rent/mortgage payments, loan payments, utilities, groceries, and other bills. Knowing what you need to cover these expenses will help you make an informed decision when setting your salary.
Make sure your business and personal expenses are separated so that you have a clear picture of your business finances.
Let's say your annual personal expenses amount to $50,000.
Step 4: Analyze Your Profit Margin
Profit margin is a key financial metric that indicates the percentage of profit a company makes after deducting all costs, including production, taxes, and operational costs, from its revenue. It's a crucial measure of financial health and profitability. Profit margin is calculated by subtracting total business expenses from total revenue, and then dividing the result by the total revenue.
In this case, your profit margin before being converted to a percentage would be $500,000 - $300,000 = $200,000.
The figure is then multiplied by 100 to convert it into a percentage. In our example, if your business generated a revenue of $500,000 and had expenses of $300,000, your profit margin would be revenue minus expense divided by revenue: ($500,000 - $300,000) / $500,000 = 40%.
This implies that for every dollar of revenue produced, your business is making a net profit of 40 cents.
Step 5: Set Your Salary
Now, decide how much of this profit margin you want to take as your salary. A good rule of thumb is to start with a lower percentage and increase it as your business grows. For instance, you might start by taking 50% of the profit as your salary. So, your salary would be $200,000 * 0.50 = $100,000.
However, remember your personal living expenses. If your calculated salary doesn't cover these, you may need to adjust the percentage accordingly.
In this example, the $100,000 salary comfortably covers the $50,000 living expenses, leaving a balance for savings or unexpected personal costs.
Determine If Your Salary is Right For You
This practical guide gives you a straightforward way to calculate your salary as a small business owner. Remember, every business is unique, and these figures are hypothetical. You should adjust based on your actual revenue, business expenses, personal expenses, and desired profit margin.
Also, consider consulting with a financial advisor or accountant to ensure you're making the best decisions for your personal finances and your business's financial health. This important step ensures you're fairly compensated for your hard work while keeping your business profitable and sustainable.
Other Common Ways Small Business Owners Pay Themselves
In addition to a salary, there are other ways small business owners pay themselves. These include dividend payments, bonuses, and profit distributions. Dividend payments are regular cash payments made to shareholders of a company based on their ownership stake (shares). Bonuses may be paid when meeting certain performance milestones or achieving specific goals. Or an owner's draw can be taken from business profits and taxes paid on it separately.
It's important to understand each of these methods and their implications for taxation before deciding how to pay yourself. Consult with an accountant or financial advisor to ensure you're making the right decisions for your business and personal finances.
Lastly, don't forget about other benefits like health insurance and retirement contributions. In addition to a salary, these are important components of a small business owner's overall compensation package. Setting aside the appropriate amount for each can help you stay on top of your finances and provide peace of mind for the future. Investing in yourself is an essential part of running a successful business.
By factoring in your total revenue, expenses, and personal living expenses, you can determine an appropriate salary for yourself as a small business owner. With careful consideration and the help of financial professionals when needed, you can ensure your business is profitable and sustainable while still providing for yourself financially. Investing in yourself now will pay dividends down the road!