For a small business owner salary is sometimes the last thing on their mind. They barely pay themselves one salary and yet I want to suggest they should be paying themselves three!
As a small business owner you relate to your business in many different ways. My mission today is to convince you to pay yourself for three of those ways. And, having done that, to show you how to calculate them.
Now don’t be like that! I can read your mind you know and I hear you saying ‘how the (expletive of your choice) can she expect me to do that when I can’t even work out how to pay myself once!’ Well I’m glad you asked – please allow me to show you how.
Small business owners wear many hats – sales manager, operations manager, customer relations, finance manager, marketing manager, web master, social media guru and the list goes on. Gerber in his book The E-myth talks about your role as Technician, Manager and Entrepreneur.
I like his distinctions but it’s not how I would divide your role up for payment purposes. In fact there is a lot I like about that book. It provides a good allegory on small business development but that is for another time.
For the purpose of remuneration I would divide your roles into:
- Chief Executive Officer
- Managing Director
Chief Executive Officer
For this role you should pay yourself a market rate of pay. We discussed one way to do this in a previous post. This reflects the work you do in running the operational side of the business. It includes all the management stuff and the many hats you wear as owner operator of a small business.
Once you have decided on the market rate of pay for this role make sure you index this figure to inflation or just choose a flat percentage increase to award yourself each year. Alternatively you can test the salary in the market place, say every three years or so, to make sure it’s realistic.
The bottom line is you should pay yourself the salary you think you would have to pay someone to replace you in this operational role on a day-to-day basis.
You should pay yourself a directors fee to reflect the work you do in overseeing the running of the company.
If you operate your business from an incorporated legal entity there will be obligations imposed on you by the company legislation in your country.
These could include things like making sure
- Proper accounting records are kept
- Adequate insurance cover is in place
- The business is solvent
- All federal and local laws relating to your particular business type are being kept
- Your products comply with safety standards
- Your workplace complies with occupational health and safety legislation and much more.
Apart from these legal obligations Directors are often involved in strategic planning and provide a big picture focus on the performance of the business.
If you have a Board of Directors then you will already know what the current market rate is for these duties. If not you could ask your accountant or lawyer or even the association of Directors in your country to find out what is appropriate.
Directors’ fees are normally calculated according to a combination of
- The turnover of the company
- Number of meetings a year
- The risk involved in the industry or company
If you don’t have a Board of Directors then feel free to make up a conservative figure and pay yourself that fee.
The chances are high that if you have started a small business you have invested cold hard cash into it in addition to your blood, sweat and tears.
And you know what?
You should get a return on that investment.
If you have already made the decision to build a brick wall between your business and personal finances then you will know exactly how much you have invested. If you haven’t taken this step yet then it could take you a while longer to add it all up – but go on, do it, cause it’s important!
Ok all you need to do now is to set a rate of interest you should be paid on the amount invested.
The easiest way to do this is to pick a bank and look at what they would charge you if you took out a business loan, or had an overdraft facility with them. You can add a fixed percentage over and above that rate if you want to but don’t go overboard on this you need to keep it on a commercial basis.
Check with your accountant to make sure you comply with any tax legislation in your country as this might be considered to be a special loan because it is from a Director.
There are plenty of online calculators on the banking websites that will help you work out a principal and interest repayment rate if you work out how many years you want to pay it back over. Otherwise I usually calculate the interest at the end of each quarter.
If you can’t afford regular repayments of the principal, then just knock a bit off at the end of each quarter, depending on how the business is performing. This just makes the interest calculation maths easier.
Why should business owners earn these three incomes?
The short answer to this is ‘because it is the sensible thing to do.’
No, this is not just the lunatic ravings of an anal retentive accountant who wants to add more and more complexity to something that should be straightforward.
It is commercial advice from someone who wants you to have a business that is glorious!
Here’s 4 reasons to treble your small business owner salary
- There may come a day when you want to step back from the operational side of running your business and employ someone else to do it. If you have always been paying yourself a commercial salary then you know your business is robust enough to be able to do it.That makes affording it a ‘no-brainer’, as they say in the classics!
- As your business grows you may want to appoint a Board of Directors to provide you with advice and direction. Many businesses have found this has propelled them to the next level.If you are paying yourself a Directors’ fee from day 1 it sets a value on this type of work and prepares you for the day when you pay others for their advice and knowledge.
- Paying yourself interest is a no brainer. If any other person or financial institution lent you money you would be paying them interest. So why should you be the exception to the rule?
- It will force a commercial robustness on you that will stand you in good stead. Yes you may not be able to pay yourself the three types of remuneration all that time but you must have that as your goal if running a commercially sound business is one of your goals.
So its over to you now. What do you think? Would you like to earn three lots of income from your business?