It’s the conundrum faced by every business owner at some point – how to pay yourself without bankrupting your business.
Geoff Richmond, Financial Results Accountant with South Australian small business consultancy Straight Talk Group says before putting a dollar value on the work that small business owners (SBOs) put into their business, they must acknowledge that paying themselves a wage has no real financial impact on the success of a business.
A business will be successful if its revenue exceeds its expenses by an amount that represents an acceptable return on investment, he says.
“The real issue is more about giving the owner a psychological lift for all the hard work they do. By acknowledging the efforts of the owner we separate the worth of the business and that of the personal efforts of the owner.”
Consider cash flow
Richmond says before determining a set amount, SBOs must first take into account things like taxes, payroll, fixed costs such as financing debtors and work in progress, and overheads such as leasing and stock.
Lisa Reed, business director with Perth-based business coaching group A Little Ray of Sunshine, says while it can be a balancing act in the early days, undertaking a cash flow forecast will aid the decision-making process.
“Forecast your business’s cash needs by week or by month. A cash flow forecast shows the inflows and outflows in your main operating bank account, and your net cash flow position as a surplus or deficit. Over a period of at least six weeks or six months you can see if it is possible to consistently pay yourself a payroll wage, and still have money in the bank to pay bills.”
If we can make more gross profit and hold overheads the same, this leads to more net profit in [your] bottom-line.
Know how to make a profit
Reed says it’s vital SBOs are aware of their break even point and know how to generate a healthy net profit consistently prior to paying themselves a real wage. She says smart SBOs spend 80 per cent of their time on maximising their gross profit.
“It’s really important you understand how to maximise the gross profit on every sale you make. If we can make more gross profit and hold overheads the same, this leads to more net profit in [your] bottom-line.”
Reed says there are three main phases of wage payments for SBOs depending on where they are in the business lifecycle.
Typically in the first three years of business, SBOs take drawings, typically in an adhoc manner, to live on. After the first year in business, most begin putting aside an amount for PAYG and superannuation when they take drawings. By the third phase SBOs should begin moving to a payroll wage that allows a SBO to plan their wage as part of the cost structure, and also set up to operate a business that is more “saleable”.
“When working out what you can afford to pay yourself each week or fortnight or month, you need to consider these three components. They should be paid all at once, with net pay going to your bank account and PAYG and Superannuation paid into a holding account until due,” Reed says.
Richmond says while the rate is entirely subjective, SBOs should never pay themselves more than their cash flow allows.
“If the business is doing well then I would suggest the measure be what the business would need to pay an arm’s length employee to take on the role of the owner.”
Tracey Porter is a career journalist whose mug shot appears everywhere from daily newspapers and online news sites to business and consumer magazine titles.