How to Pay Yourself. A Guide for Small Business Owners. Andrea Travillian, Take a Smart Step

Transcription

1 A Guide for Small Business Owners Andrea Travillian, Take a Smart Step

2 Introduction Most business owners are optimistic. If they weren t, not many businesses would get started after all, it is hard work. However, there is one small problem with this optimism. Small business owners have the tendency to think the next big idea is going be the thing that's going bring in piles of money; that next idea is going be even bigger and better than the last idea. And while this is a fabulous trait because it is crucial to being a successful entrepreneur, it also puts business owners in a very bad situation. Specifically, many will avoid taking care of their own personal finances, including retirement, in exchange for continual growth and survival of the company. So how do you create a dividing line between what your business needs to continue growing and what you need to create a solid financial future? Well, I wish I could say there is one straightforward, clear answer, but it's just not possible as every business and life situation is different. So instead, I'm going to give you some tips for figuring out what to take out, what to leave in, why you actually need to focus on taking money out, and what you ultimately want from your business.

3 Purpose of Your Business Before we get into how to pay yourself, let s review why you are actually in business for yourself. Entrepreneurs tend to be a passionate lot, and often have a purpose or mission that goes with their business. While this is great, many times we forget that there is one other very important purpose for our business to create a living and financial independence for ourselves. Otherwise, we would have structured the business as a non-profit. With that in mind, every time you're making a financial decision for your business, remind yourself that in addition to all the wonderful things your business is creating for others, its other purpose is to take care of you and your financial needs. There are two ways to ensure that your business is taking care of your financial needs. The first way is to pay yourself a salary that is enough to cover your basic needs and also begin to create wealth by withdrawing profits. The second way your business can take care of your needs is to become a business that you can sell. Upon the sale of the business the proceeds would add to your nest egg for retirement. For the purposes of this guide, we will focus on the first way that your business supports you paying you a salary and withdrawing profits. The second approach requires a certain amount of factors to be in place before someone will consider buying it, such as processes, sales staff and management.. If you want assistance in making sure you can sell your business, you can talk to a business broker or consider a strategy session with me to review your options.

4 Why You Need to Take Profits Out Why do you need to take out money and filter it back into your personal accounts? Ultimately, you want to ensure that when you are done working you have the means to take care of yourself and your family. When you run your own business you don't have the benefits of a pension, or somebody else setting up a 401k plan for you. Nobody has taken care of the retirement stuff for you, and if you haven't been paying yourself a salary, you might not even have social security available to fall back on (if it is even still around). Thus it's crucial to your future self to have some sort of retirement plan set up or wealth that you have created to live off of. Most entrepreneurs believe that they're never going to stop working or that they are happy the way they are. However, you need to plan for the opposite because burnout, disabilities and changing markets can interrupt your plans to keep working. We may want to work forever, but life might have other things in mind. You don't know what your life holds in the next 20 to 25 years so it is better to plan for all possibilities. I know way too many entrepreneurs and regular everyday people who didn't plan because they thought they were going to be fine and work forever. They suddenly found they were not physically or mentally able to do so. You need to start saving for your retirement and life after business. How do you accomplish saving while paying your regular expenses? The easiest way is to pay yourself a salary. I know this seems like a duh type of issue, yet I know a lot of business owners that are not doing this, or are not doing this properly. Yet this is the key to ensuring that you are taking care of your own personal finances and not just the business. First, let s dive in to how to pay yourself the proper way that will make your CPA and the IRS jump for joy because you did it right!

5 The Right Way to Pay Yourself a Salary Depending on the structure of your business, your salary will be classified differently and will also be recorded differently for tax purposes. Here is a brief review, however, please consult your CPA or tax attorney for specifics regarding your company and personal tax situation. Sole Proprietor You are the business, thus there is no tax differentiation. You file on a Schedule C, therefore, your taxable income is revenues expenses. You pay yourself by writing a check from the business account. Don t forget to save for taxes in a separate account, or immediately make estimated payments to the IRS. Partnership A partnership is similar to the sole proprietor in that it is the same calculation and that taxes are done on your return and your partners. You file a 1065 and issue K-1 s. Corporation If you are a C-corp you will get a salary for working in the business. The profits of the business stay with the business and are taxed under the business. You can take out extra profits by issuing dividends to the owners after you pay yourself a salary. S-Corp This is a corporation that has opted to file taxes as an S-corp. Instead of the business paying taxes on the profits, they flow through to the tax returns of the owners. You still file a corporate return, but pay the tax with your personal taxes. You would be an employee who takes a salary like the C-corp and also issues dividends of excess profit. LLC With the LLC it depends on the set up of the entity. Some are set as a single owner and others are with more than one owner. With the single owner you would run things like you would as a single corporation or a sole proprietor. With more than one owner you choose between a partnership or corporation structure.

6 Taking profits out after paying yourself a salary is known as paying Dividends, a Draw, or a Distribution depending on your structure. Please do not just start writing checks to yourself from an account without ensuring you know how you are supposed to be recording payments and also making sure you cover what you need to for taxes. When in doubt ask your CPA or bookkeeper.

7 Making Payments Regularly Now that you know how to pay yourself, it is time to figure out how to actually make that a reality. While there are multiple stages to growing a business, for the case of paying yourself we are going to divide it into two stage:l start-up and established. The biggest difference in these two will be profit. At the start-up phase you are still getting things up and running and may not be collecting any profit. At this phase it is really hard to pay yourself a salary, unless your wealthy aunt is bankrolling your business and is allowing for management wages! The established phase is when you begin to have a profit, and can build your salary into your budget. ***Caution*** Do not get caught up in the idea that it will take a long time to turn a profit and that you must continually be investing in the business. Following this myth will leave you broke and put your business in a position where it cannot be sold. Most small businesses cannot be run like bigger tech start-ups where venture capital and an eventual IPO will save your personal finances! Ignore the start-up media when it comes to your small business and paying yourself!

8 With that rant over, let s take a look at paying yourself at each stage. Start-up For this one, I am not going to spend too much time on this as that is another report all together! However, I did want to give you some ideas in case you are still in the start-up phase. At this stage it may not be practical to take any money out, but if you are already in your business full time and need the money, you should calculate exactly how much you need to cover expenses and add that much to your business budget. As far as getting the money to actually pay yourself you will need to balance out all your business expenses with how much you need to pay yourself. You may have to cut back on marketing expenses or let go of a subscription that you don t need. Other alternatives might be finding another funding source. This article may be helpful for you to brainstorm some ideas on funding: How to Fund a Small Business You could also reduce your personal expenses to cut back on how much you need from the business. Finally, if you need to it might be time to get a part time job outside your business to keep things going on the personal side.

9 Established Business Once you are making a regular profit you will need to add a salary for yourself to your company P&L (profit and loss) planning. By budgeting in your salary you won t find yourself waiting until the end of the month and taking what is left over. Instead you get a regular check that you planned for. How do you determine how much to pay yourself? You have a few alternatives depending on what stage of business you are in. Base your salary on what you could make at another job. For example, if you're a virtual assistant and you're working part-time, how much could you make being an assistant at a local business part-time? Pay yourself a manager s salary. For example, if you are a website developer, what would you make if you were a manager at a company doing the same thing? This is a great one if you have employees that you manage in addition to doing the work. Take a percentage of revenues. For example, if you are a coach then you could take fifty percent of coaching fees. This is more like being on a commission. What would you pay someone to come in and do your job? As you grow and replace yourself, what would you have to pay that person? This is a great place to start a salary for you. This is something that you may want to figure out with your CPA. They can be very helpful because they have an inside view of what other businesses are doing and what might be a good salary for your business. In addition, they will help you stay on the right side of the IRS. Depending on your structure there are considerations such as excessive compensation and double taxation.

10 If your business is newer, keep in mind that this does not have to be the full salary you would eventually like to have. Select a pay that will help you get into the practice of budgeting for and paying yourself and grow it over time. As an example, if you are putting yourself on a commission basis, maybe you start at 10 percent and work up to 50 percent.

11 Setting Up Payment Once you have decided how much you are going to pay yourself, you actually have to pay yourself! The easiest way to do this is to outsource to a payroll company or your CPA/bookkeeper. A payroll company will ensure that you are deducting the right taxes, paying them and will ensure your check ends up in your bank account each month. Unless you are a CPA or bookkeeper then I highly recommend you outsource this. The only time I would say you would be okay skipping this service is if you are a sole proprietor or partnership. You just need to ensure that you are setting aside tax money with each paycheck. Two companies with reasonable costs to consider are ZenPayroll or Intuit QuickBooks Payroll. Otherwise ask your CPA what they charge or who they recommend.

12 Exceptions to Paying Yourself Occasionally you may come across times when you as the owner of the company needs to pass on your pay. These instances should be the exception rather than the rule. If you are consistently not paying yourself then you need to reevaluate why and what you can do about it. Here are some exceptions: Cash Flow timing You may set it up to pay yourself on the 15 th of every month, but a major client has delayed payment and you don t have the cash. You can adjust your pay date, or increase the amount the next payroll period. This will help ensure you don t overdraw your bank account. Make payroll If you have employees and did not make enough profit this month to cover payroll, skip yourself first. Just make sure that this does not become a regular occurrence! Large Investment If you have a large purchase you want to make and have done the needed ROI calculations, and are okay at home financially you may consider skipping a check to invest in the business. This last one brings us to the final section on paying yourself from your business: how to decide when to take out extra money instead of reinvesting it into the business.

13 Withdrawing Money to Create Wealth The next step with your business should be to take out some profits to begin creating wealth outside of your business. This requires deciding whether to take money out or to reinvest into your company so it can continue to grow. One quick side note - if you don t have a business emergency fund then set this up before you take money out beyond your salary. There is no right answer to this, but here are some questions and information to help you make your decision. For reinvestment purposes, you need to decide: Are you happy with your current growth? Do you want to grow more? At what pace do you want to grow? And then if you're a product-based business: Do I want to add a product? Do I need to continue to develop my product? Now, the answer to these questions will dictate how much money you put back into the business. If you're perfectly happy with where the business is, you have more clients than you can handle, and you're happy, then start taking the money out and start improving your personal finances. Just because everyone else wants to keep growing does not mean you need to remember your business is your business. You get to decide! However, if you would continue to like to grow or you want to expand upon your products, the next step is to determine how much to leave in the business and how much to take out.

14 From a product perspective a common method for research and development budgets is to commit a percentage of revenue to this budget item. You will find most major companies such as Johnson & Johnson, Proctor & Gamble, and Con Agra the large companies that have a research department use a fixed percentage to determine how much that gets put back into R&D. You might try this approach by taking 10% (or whatever you decide is right for you), which goes into your budget in the R&D category. A quick example would be: Your revenue is $100,000, so your R&D/growth budget would be $10,000 (10% of your revenue). For a service-based business you could use the same approach where you are continually putting money towards creating new services. You also have the ability to take new services on a one by one basis, and budget them in to your P&L as they come up. If you are more concerned about training and development than growing offerings, you can also add in a development category in your budget. Then, when you need to learn a new skill or learn about the latest social media tool, you'll have a preset amount that you can spend. If you do not budget for these expenses you might end up spending all your profit, since the funds have not been planned out in advance. All remaining profits should come out of the business and into your pocket as a dividend! Again, make sure you have a plan for these funds so you don t spend all of them on fun stuff. Invest some in paper assets or real estate and spend some money! While none of these decisions are ever easy to make and there's lots of different right decisions, taking the time to understand your numbers and what you and your business need in the future will leave both of you in a stronger position.

15 What to Do Next Smart Step, Inc assists small businesses in moving up the growth pyramid to create strong businesses that support the owner. To help business owners understand where they are on the pyramid, we developed the Pyramid Growth Assessment, which we conduct over the phone or Skype. Here is what we accomplish together in this 30 minute session: Determine where you are on the pyramid this ensures you have all the foundation pieces in place and don t have to rebuild your business later. Determine what the best strategy is for getting you to the next level you want to be at this helps you answer the growth questions from above and know where you should be investing your time and money. Determine if your personal finances are set to carry you into retirement and how you might make adjustments to your current plan. The Pyramid Growth Assessment is conducted by Andrea Travillian, the founder of Smart Step, Inc. Andrea has expertise not only in small business, but investing and strategy for large companies and individuals. Please be assured that this is not a thinly disguised sales presentation; it will be a full strategy session and will cover as much as we can in 30 minutes. There is no charge for this call, but please keep in mind it will be strictly limited to 30 minutes. To secure a time for your call, After you have signed up for a time, you will receive a pre-session questionnaire that will help you get the most from your session.