When you first contemplated running your own business, you probably weren’t looking for an immediate paycheck. After all, if you’re brick-and-mortar, you have rent, phone, utilities, and furniture. If you’re into retail, whether online or off, you’ve got to have inventory and a place to store your wares. And regardless of whether you’re running your business online or in a physical location, you’ll want business cards/stationery, a website, and advertising. You may need to invest in expensive electronic equipment and software. Even if operating your business from home, you’ll need to dedicate some square footage to office and inventory space. You’ll quite likely need licenses, fees, and permits. And taxes. Plus payroll, even if there’s no one else involved in your business, and it’s just you as a sole proprietor.
How you pay yourself is dictated by law in some cases, convention in others
You may not know what to expect when considering your organization’s potential income, which brings up the problem of how to set a budgeted amount when you don’t know what’s coming in. There’s the important consideration of how to pay yourself when beginning your startup. First, you need to know what the law says for your type of business. Just how do you pay yourself – will it be a salary or a draw? Whatever method you take, you need to consider how each is taxed. You also need to know how each business type generally pays the owner(s), partners, shareholders, or corporate execs.
- If you as the business owner are also a corporate shareholder, your money comes as a dividend.
- A distributive share considers the owner’s share in business funds and then takes money on profits made. Partners, corporate and S corporation shareholders, LLCs with more than one member, and other corporate executives or employees all take a distributive share.
- A draw happens when the owner takes money directly from what comes in. This is how sole proprietors generally pay themselves.
- Your money may come as a paycheck, where you set a dollar amount and a schedule in which you record your payday. Many corporate executives take their money this way, and so will you if you’ve chosen to set yourself up as an employee.
For more information on the different ways you can pay yourself, refer to The Balance Small Business’s article, “How to Pay Yourself From Your Business” by Jean Murray (May 2020). For an in-depth review of taxes, equity, assets, and liabilities, turn to the Intuit/QuickBooks website article, “Salary vs. draw: How to pay yourself as a business owner” by Kat Boogaard (December 2020).
The research firm PayScale provides lots of details on making pay decisions. For example, in case you want to know how much other entrepreneurs are making, they list the average annual salary for small business owners at $68,000 as reported by 350 or so companies.
An emergency fund: Accounting for the unforeseen
Of course, lots of factors determine just what you can afford. Some can be budgeted for. Others aren’t so easy to foresee. With the pandemic so fresh on most people’s minds, accounting for the unknown is a big consideration. Another major factor needs to be answered before you set your salary. You need to take a long look at your household budget. In addition to meeting the cost of doing business, be sure to set a realistic figure to meet your household expenses.
You should also consider the challenges that you could be faced with and how you’ll adapt to a constantly changing market. Conventional wisdom dictates that in accounting for the unexpected in your household, you should save at least three to six months' worth of salary in an account by itself to cover expenses. That money is an emergency fund and shouldn’t be used for any other purpose. Why not use that same logic for your business?
The biggest proactive reason for saving for urgent business expenses is of course that in the short-term at least, you should be able to keep your business running.
The biggest reason against setting up an emergency fund? If the money you save shouldn’t be touched for any reason other than a genuine emergency, it follows that you shouldn’t use that money as an investment. So what could be a sizable amount to be invested in your startup is instead sitting somewhere safe from market vagaries. In other words, you should put it somewhere safe. Somewhere safe means you won’t be able to make much money from it or use it for non-emergency necessities.
Like determining what to save for an emergency, I haven’t seen a consensus or hard formula you can use to know how much you should take home. Consider your business needs, your household and self-maintenance needs, the unforeseen, and even the salaries generally paid to employees in positions equivalent to yours.
You’re in business for any number of reasons, the money you make undoubtedly being an important one.