When you first start a business, one of the most common questions is: how do I pay myself as a business owner?
Business ownership comes with a myriad of financial considerations. Taxes, owner's pay, deductible expenses... These things can feel complicated!
How and when you, as an owner, should take money out of your business is a pivotal decision. This process requires strategic planning, a keen understanding of your business's finances, and an unwavering commitment to your company's long-term growth.
Planning for your own pay is essential. You need to make a living after all!
This article will guide you through the essentials of making responsible financial decisions as a business owner.
How Your Business Makes Money
Before delving into how you should withdraw money from your business, it's essential to understand how your business generates income in the first place.
Your business generates money by selling products or services to clients. You supply a product or service and receive money in exchange!
A well-structured business model can translate to healthy profits, but that doesn't mean those profits are up for grabs.
Understanding your revenue streams (where your money comes from), profit margins (how much money you're making after Cost of Goods), and cash flow management all play a role in determining how much money is available at the end of the day.
Many business owners look at their Statement of Profit and Loss for guidance on how much money their business makes in a given period. The Profit and Loss is a handy tool for seeing a business's Income and Expenses, but other vital cash-flow-related transactions occur beyond the Profit and Loss.
For instance, debt and distributions are financial transactions that typically only appear on your Balance Sheet or Statement of Cash Flows!
When your business receives an infusion of cash from a new loan, that amount is established on your Balance Sheet. As you make payments, your business is only able to recognize an expense for the interest that you pay; the actual repayment of cash to the lender is not an expense, rather it's the settlement of a liability!
When your business distributes cash to its shareholders, these distributions are not an expense to the business, either. Instead, it's a distribution from the retained equity of the business to the owners. It's simply cash leaving the bank!
These two things, debt, and distributions, can often cause cashflow issues if not appropriately monitored mainly because they will not show up in your P&L.
Your Business Needs a Bank
Your business should be distinctly separate from your finances for optimal organization. This separation is vital to planning out your compensation as a business owner!
Running a business out of your personal bank account isn't just disorganized; it's a recipe for financial disaster.
A dedicated business bank account provides a clear separation between your personal and business finances, making it easier to manage cash flow and track expenses.
Plus, it helps maintain legal protections in place if your business is a separate legal entity!
Having a business bank account is a necessity in creating a structure that will protect your business for the long term. Without separating your personal and business finances, taking money out of the business can create a confusing mess.
A separate account for your business forces you as the business owner to move money either through payroll or through a distribution of cash from one bank account to another, rather than comingling your funds.
Types of Owner's Pay
When it comes to owner compensation, planning is paramount.
Establishing a regular pay schedule is prudent, much like you would for any employee. This ensures a steady income and maintains a consistent cash flow within the business. The exact amount can vary based on the business's profitability, but it should always be budgeted and accounted for in your business's financial planning.
The actual format in which your business can pay you may depend on your business structure. S-Corporations, for example, are required to pay their owners a "reasonable salary" according to the IRS. This means that the owner of an S-Corp is most likely required to receive an actual wage from the business!
On the flip side, single-member LLCs structured as pass-through entities can usually distribute money directly to the owner.
The type of compensation your business can pay you as an owner largely depends on the corporate structure, tax election, and many other factors. Working with a qualified tax professional is essential to stay compliant in all situations!
Planning for Growth
While enjoying the fruits of your hard work immediately might be tempting, sustainable business growth often requires reinvestment.
Profits funneled back into the business can fund expansion efforts, cover unexpected expenses, or build a cushion. You invest in your business's future by being cautious about how much money you take out!
Taking money out of your business requires a delicate balancing act between rewarding yourself for your hard work and ensuring the financial stability of your business.
By understanding how your business makes money, maintaining a separate bank account, planning your pay strategically, and prioritizing your business's growth, you can make responsible decisions that serve you and your company well in the long run.