Let’s face it, every entrepreneur wants (and needs) to get paid. This is the foundation for a sustainable business trajectory.
The difficulty comes in deciding how much your business should pay you. Although there’s no specific formula that covers all cases, the following standard factors can help you make this all-important decision:
The first element to consider is timing; your compensation as owner must not negatively impact the health of the business. For instance, in the early planning stage, the company has no revenue but probably has lots of start-up expenses. At this point, it doesn’t provide cash to feed you; rather, you are feeding it.
When your operation is generating revenue, sustaining the momentum is paramount. In the first six months or so, the business builds cash for expansion, so you don’t take any distributions in that time period. However, after six months, you need to take a distribution; after spending all your time and resources, it’s crucial to your psychological well-being that you pay yourself something.
You are the most important – and possibly only – employee of your business. Even small recurring compensation demonstrates that the company exists to reward individual effort. This also means that predictable owner distributions become part of the business cash flow along with general operating expenses.
After a bit of history with your business, you’re able to build a financial forecast. This considers your available resources – especially money – and predicts future revenue along with expenditures. Your owner compensation is one of the cash outflow categories. The budget should allow your pay to be adjusted based on other required costs for business operations.
Not all of the outgoing cash is for recurring overhead expenses. For instance, if your company sells products, funds are needed to replace inventory. Likewise, a service-oriented business may need parts or materials for the projects expected in upcoming months. Or maybe you’ll require extra cash for necessary travel or subcontractors. The company bears these costs prior to getting paid by customers.
The key is remembering that your primary concern is the strength of the business, and you need to have a cushion of cash to reinvest in it. However, one of the costs of conducting operations is your labor. While you don’t want to bleed the company dry, some amount of recurring compensation is reasonable. Find that amount in the company budget and pay yourself consistently. As you reinvest cash for growth, the cash cushion should rise, allowing you to take larger distributions in the future.
Do you have investors or have you borrowed from financial institutions? Investors generally want to know that you are being paid by the business, and will usually set your salary ceiling along with performance goals. Lenders, too, want to see owner compensation as an indication you have an incentive to grow the business. Note that demonstrating sufficient cash flow for debt repayment is easier if your historical compensation is a consistent amount; variances complicate lenders’ abilities to evaluate cash flow.