Paying yourself as a small business owner
How much should I pay myself?
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?
This question is hard 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 you 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 use this to work out a fair wage 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.
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 question. A basic answer would be: “when your business breaks even”, however this comes with some caveats.
For instance, it’s not enough to just breakeven - 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 on 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: Time 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.
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 is simply a suggested method. Source
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 works quite differently, 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 strive for more you need to register yourself as an employer on the Gov.uk website. From there you will receive two letter 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.
So it’s important to consider the legal structure of your business. How much you can pay yourself, and when, might be restricted by the legal structure of the business you run:
- As a sole trader you can pay yourself mostly what you wish to from your profits.
- Limited companies will usually be on the HMRC and receive a regular stipulated wage like any other employee you may go on to hire.
There is a lot to consider when deciding how much to pay yourself as a business owner. Not only do you need to consider to wellbeing of your business by ensuring that your financial model is able to sustain your wage, but you also need to consider the tax and legal implications of the amount that you pay yourself. However, it’s important to revisit the amount that you get paid at least once a year to ensure that the currents state of your business and its performance accurately reflects your wage.