Many business owners find it difficult to ascertain their salary in the capacity of an entrepreneur. Despite having the freedom of doing so, it sounds easier as a theory than it is in reality.
The simple questions like: how, how much and when of determining the salary of a business owner depends on several factors. However, it is important to keep in mind that a reasonable amount of compensation is to be calculated for the owner’s time, responsibility and efforts. The fact that a business owner takes risks and helps grow the business, he deserves to be paid. At the same time, one needs to remember that the primary aim of the owner is to achieve long-term goals and not to earn a monthly payout or salary. 1.
Nature and Structure of Company
Whether the setup is a Sole Proprietorship, Partnership or a Private Limited determines the salary of an entrepreneur, partner or the director, to a large extent. For example, for a sole proprietorship firm, the net income as reported in the balance sheet is the salary and there is no formal paycheck setup. However, in case of a corporation, the business owner is an employee and has all the right to derive wages or salary. In fact in such a setup the owner reaps profits in addition to the monthly salary as against in a sole proprietorship. On the other hand, any profit generated in a partnership firm is also treated as personal income of the partners.
It is advisable to contact an accountant before deciding on a figure and thereby be within the regulatory norms. Paying the business owner, a salary can be at times favorable for the business entity from the point of view of tax authorities.
Stage of Business
Stage of business decides the salary that a business owner can withdraw. The salary gradually increases with the stage of business that is, as the business matures salary of the owner also increases. The owner of a startup, for example, will be able to draw the lesser amount as compared to an owner of a well-settled business. As a startup, the owner can withdraw a minimum amount to meet the basic expenses for about six to eighteen months, keeping in mind the profitability of the company as well. Even if the company is in the early stage of growth, it is advisable that the owner draws a salary in order to gauge its success. Once the business starts showing steady profits, the owner can increase the take-home pay or even withdraw the yearly or quarterly bonus.
If the goal is to grow the business exponentially, then the owner should forego some portion of his fixed salary till sometime. Stage of business in terms of the business cycle is to be studied in order to come to a conclusion. The current expenses should be considered as a base for future terms as a starting point while calculating the salary.
Assess your job
It is important to study one’s skills and efforts before calculating the pay. Own contribution to the company is necessary to be studied. In some setups, the owner is the chief salesperson and in some they play a managerial or administrative role alone. Hence, it is imperative to understand what is invested, thus the benefits will be accordingly calculated.
An owner should pay himself what he is worth of (howsoever subjective assessment it is) it is essential to be carried out. Strategic planning is required to arrive at the final amount to be withdrawn. Hence, to begin with, one should analyze the personal financial statement considering all living expenses and liabilities. The sum of these is the minimum basic that the owner should draw home. Compensation also varies according to the experience and skill-set of the owner.
Industry Standard or using benchmarks
The market standard in terms of salary or take home of the entrepreneurs/peers/competitors should be studied in order to understand the average pay. One should ensure that the self-pay should not be higher than the average until and unless the company is making profits and is on the growth path as planned. Benchmarks are to be only indicative of what should be drawn as a salary and not necessarily to be aped completely. Usually, a company half the size or double the size in terms of revenue should be compared in the same geography. Companies in same financial condition and industry should be looked upon to draw relevant reference.
An entrepreneur should consider seeking advice of an accountant in order to analyze the fixed and variable costs including taxes, operating costs, loans and advances, marketing etc. and thereby arrive at a figure which ought to be withdrawn as a salary. In case of an established business enterprise, the owner can decide to participate in the profit margin, however, the percentage of it needs to be derived at only after consulting with a professional. With the professional help, a fair and reasonable amount of salary can be arrived at.
An entrepreneur’s salary is directly linked to the profitability of his company. When the business is considerably profitable, it is time to re-evaluate the salary. A smart move is the one wherein at the initial stage the entrepreneur derives a relatively lower pay and reinvests a major portion of profits in business. In addition to the company’s profitability, a business owner should consider the macro economic conditions, the complexity of business and his future growth plans with respect to the enterprise. When an enterprise has just reached its break-even, i.e., it is not yet profitable, the owner should not draw a higher pay. It is not the ideal time to revisit the take-home.
What is important to be noted here is that if a business achieves break-even without the entrepreneur taking a salary, that profit is not real and any income or cash flow projections will be inaccurate. If the company approaches investors for further investment, the owner’s salary is considered with other factors before lending further. Additionally, the employee’s salary should also be intelligently calculated including the bonus, commission etc. in order to create less pressure on the income at early stages of the startup.
Further planning your own pay would need planning and application of simple mathematics. Planning here will include budgeting of both short terms and long terms personal financials and expenses and debts. With simple mathematics, you can determine how much salary will be enough to cover your basic expense.
Instances when the salary is not to be withdrawn
There are instances when an entrepreneur should not withdraw a salary like: not having enough cash flows to pay salaries of employees or routine expenses of the company or if significant expenses are lined up for the recent future, etc. The business owner should have the prudence to decide when to draw and how much to draw.
To summarize, it is understood that there is less flexibility in setting one’s compensation and different strategies are implemented at different stages of the business. A business plan with clear financial forecasts is needed to arrive at a figure.