Business owners are compensated with equity in the company, but they still need a salary to live on. Setting a salary can be tricky as you’ll want to be compensated for your work, while also not taking away from the future growth of the company. How should you set your salary?
Setting your salary
There are a few different ways to determine the appropriate salary for the business owner. The first and most important method is based on company specific financials. If you’re boot-strapping your business, then you’ll need to determine how much net income is available or cash on the balance sheet. Then, you’ll need to identify the amount of your personal monthly expenses. If the cash flow on your balance sheet and expected monthly cash flow exceed your monthly personal expenses, then you can at least pay yourself some sort of a salary. Still, how much should you be paid in salary?
How much will the market pay you?
If you were not working for yourself and were employed by another company, you need to determine how much you would be compensated given your skills and experience. If your company has enough cash flow to meet this comparable salary, then you can certainly justify paying yourself this type of salary. The caveat to this approach is that another employer likely has a significantly larger balance sheet, in which the risk to paying you this salary is a lot lower than if you paid yourself this same amount.
Another approach is to perform comparable analysis. For instance, you can try to obtain salary figures for other business owners in your industry and locations to compare to your pay. The problem with this approach is that every company is in a different financial situation.
What’s the best approach to setting a salary?
We believe it’s best to consider all of the above factors: company cash flow, individual market value, and competitor salaries in determining the appropriate salary. However, company specific performance should play the greatest role in calculating a final salary. For instance, you could pay a salary that covers your personal monthly expenses plus two additional months of expenses and then pay the rest in bonuses based on company performance. This methodology will reduce the risk that you pigeon hole yourself by paying too large of a salary, while also holding yourself accountable.
BIDaWIZ is an online marketplace where small businesses can obtain professional tax, accounting and financial advice and services from a network of over 750 online CPAs, EAs, CFPs & Tax JDs. BIDaWIZ suite of services include the ability to ask professionals finance and tax questions for free, find an accountant online and work with them, and to subscribe to the premium tax and financial newsletter and knowledge base.