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How do I pay myself as a small business owner?

This is a question that every entrepreneur faces when starting up. Unfortunately, it’s also a question that has no obvious answer. Should you pay yourself just enough to get by? Or should you be rewarded for your significant efforts early on?

The rational argument would be to keep your pay at a conservative level until your business is turning a profit. But, even once you’re turning a profit, what is a fair wage for your time and efforts?

Here we look at how to go about paying yourself and the things you need to consider before doing so. 

How much should I pay myself?

This is a hard question to answer with definitive figures.

On an anecdotal level, the amount that you pay yourself should come down to your business and its circumstances - taking into account factors such as the industry your operate in, your business model and your turnover.

Ultimately, you should aim to strike a balance between investment in your business, and paying yourself a wage. Often when starting out in business entrepreneurs will take a basic wage to simply cover living expenses in order to provide their business with maximum investment and reduce the amount of start-up capital needed.

To do this, you need to work out your basic worth, and this can be done by following the steps below.

Step 1: Take your basic worth (the minimum you want to make when going into business).

Step 2: Divide it by 12.

Step 3: Times the rate of inflation by 4.

Step 4: This gives you the % to add to your monthly income.

For example*:

Basic worth: £25,000

Monthly wage: £2166.66

Inflation rate: 4% x 4 = 16%

New monthly wage: £2166.66 + 16% = £2512.66

New yearly wage: £2512.66 x 12 = £30,151.92

When can I increase my salary?

Again, every business is different, so there is no one size fits all answer to this questions. A primitive answer would be: “when your business breaks even”, however this comes with some caveats.

For instance, it’s not enough to just break even - you must also ensure that your business is financially stable. This is because every overhead that is inflated will impact your business’s overall cash flow. This means paying yourself more when it cannot be sustained by your business could have a detrimental impact to your growth.

To avoid this happening to your business, it can help to tie your salary in with your business’s growth.

For example, if your business grows by 5% over a quarter, then reward yourself with a quarterly wage bonus of the same amount.

Step 1: Take your monthly wage.

Step 2: Times it by 3 (number of months in a quarter).

Step 3: Work out your bonus % based on the growth % of your business against your quarterly wage.

For example*:

Monthly wage: £2512.66

Quarterly wage: £2512.66 x 3 = £7537.98

Bonus for the quarter: 5% of £7537.98 = £376.89

*Please note: There are a number of ways that that you can arrive at a figure when working out how much you should pay yourself. The above are simply suggested methods.

Reassess your salary once a year based on your business’s growth and performance. But, above all remember to be realistic with your wage, and make sure it’s financially sustainable for your business’s financial model first and foremost.

How do I pay myself?

First thing to mention is that there is a difference between being a sole trader and a limited company. If you’re a sole trader all profit earned is yours, this is different from taking a wage and is classed as “business drawings”. But, you are personably liable (you have unlimited liability) for your tax bills, so ensure that you properly record any drawings you take from the business.

If you don’t pay your tax HMRC will come for your personal assets. Remember, the money you withdraw from your business is not taxable – but, your profit, or income, is.

A common way of dealing with tax for sole traders is to set up a separate tax savings bank account where you should aim to deposit up to 25% of all net income. This way, at the end of the tax year you will pay a self-assessment bill. You should speak with your accountant on whether you need to have another bank account for your VAT.

If you are a limited company paying yourself, things works quite differently. This is because you are an employee of the company, even if you are the sole employee.

It’s helpful to think of your business and yourself as two separate entities. If you pay yourself under £486 per month you can be exempt from paying tax, yet if you earn more, then you need to register yourself as an employer on the website. From there you will receive two letters from HMRC which will include your PAYE and Accounts Office references and your activation code for PAYE online. After this you will need to set up a payroll. Visit the Government website for more information on setting up and running a payroll.

As you can see there’s a lot more to consider when deciding how much to pay yourself as a business owner, other than the figure that you will be bringing home every month. You should also take into the account the tax implications that your monthly wage has, and most importantly, whether it’s financially feasible for your business to support your desired wage.