Starting a business – when is it safe to start paying yourself?
One of the key questions new business owners should ask themselves is ‘can this business afford to pay me?’
It’s one of the better reality checks you can apply to your business idea, because if you can’t afford to pay yourself a wage or at least see the path to paying yourself, it’s probably not a viable business.
While paying yourself a wage straight away would be great, the reality for most is that it takes several months, or longer, to get the business in a position to be able to afford it.
That’s because cash flow can be an absolute killer for young businesses, so expenses are going to be a bit more important than your own remuneration in the beginning.
Knowing this, it’s important to figure out how much you’ll need to set aside to live on while the business finds its feet.
But having a plan to paying yourself (and sticking to it) is good discipline and should be an important part of your business strategy.
This means you can factor in your living costs as one of the operating costs of the business and ensures you’re more likely to get paid regularly.
Is there a formula to figuring how much I should pay myself?
This is a key question to ask your accountant when you’re planning your business.
What you’re looking for is the payment option that, based on your personal circumstances, is most tax effective.
This could be a salary, dividend or drawings – or a combination of all three – that provides the best return based on your needs and situation.
In thinking about setting a salary, after you’ve looked at the tax implications, you should also think about the long-term future of the business.
For example, when it comes time to sell the business a buyer wants to know they can draw an income from it from day one.
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When and how should you review your own pay?
It’s a good idea to set yourself an annual income review as part of your regular planning cycle.
This will help you evaluate whether the business is returning what you expected, whether you need to change anything to stimulate more growth, and if you can afford to pay yourself more in return for exceeding performance targets.
Again, it’s likely most small business owners, especially in the start-up stages, will be looking at what they can afford to pay themselves more regularly.
But once you get into a pattern, it is important to regularly review – and keep in touch with your accountant to see if the arrangement you set up at the outset is still the best one for your business.
What are some common mistakes business owners make in this area?
Business owners tend to pay themselves either too little or too much.
Many start out setting themselves what they think is a reasonable level of remuneration without considering the additional responsibilities of running a business.
Because you aren’t just ‘buying a job’; as the business owner you’re responsible for everything – from sales and marketing to tax management – and all these responsibilities take time.
A good indicator is to add up all the hours you put into the business and divide that by your actual salary.
If it’s less than the minimum wage – and it often is for small business owners – then something needs to change.
On the other end of the scale, business owners can be tempted to take more cash out of the business than it can really afford, especially when things seem to be going well.
This comes down to understanding cash flow; even if you’ve had a great month, buying that new ute might be best left if you’re heading into a slow period, with a large tax bill to pay.
Start using payroll early
You don’t need staff to start using payroll.
Firstly, you’re considered an employee if your remuneration includes a salary component and a payroll system will help take care of your pay and tax calculations, PAYE withholdings and holiday entitlements.
Secondly, if you deal with contractors receiving regular payments, then you’re required to withhold tax for reporting and payment directly to Inland Revenue and paying the contractor the balance.
Thirdly, putting a good payroll system in place early helps you familiarise yourself with the process and rules. This will avoid a steep learning curve when it comes to hire.
Low cost, cloud-based solutions like MYOB Essentials, include payroll for one in the subscription, so perfect for starting out.
Key tips for getting your pay right
- Be realistic. The first test of your business should be can it pay you the income you need.
- Understand your business. Keep regular track of your business’ key performance indicators, especially cash flow.
- Get advice. The advice of a good accountant or business advisor in this area can make a real difference.
- Use payroll early. Familiarise yourself with payroll rules and processes when paying yourself a salary and dealing with contactors receiving scheduler payments