And why does it matter so much to your business?
So you’ve run your business for a while and you pay your staff a regular wage of course, but you yourself just draw money out of the account as you need it and when it’s available for you to draw, right?
Yep, of course… Why take money out of the business if you can do without it right now? You’ll get yours later, right? And your accountant sorts out what to pay you for the purposes of the tax department at the end of the year, right?
To take your business to the next level, to reach the next level of maturity and sustainability in your business, you have to start paying yourself a regular weekly or monthly wage, religiously, every month, and you have to start to pay yourself first, before any other bastard gets a cent.
Here’s why it matters so much to the long term health and solidity of your business.
Clearly, a big factor in how much profit your business makes and whether or not the business has the cash to pay it’s bills is how much money you personally draw out of the business at any one time. If your business turns over half a million dollars and you have 4 employees and an office and you pull out $200K yourself every year there may not be enough money left to pay for Cost of Sales, staff wages and overheads (or tax, for that matter), and if you pull out nothing at all, it might look like your business is enormously profitable. Your wages, drawings or dividends are a significant factor influencing the health of the company.
So wat’s wrong with letting your drawings depend on whether there’s enough money in the bank to pull some out?
As I’ve said many times elsewhere:
If your business doesn’t make profit, it’s a hobby.
A healthy small business ought to make somewhere north of 5% net profit before tax, every year. I generally advise my clients to aim around 10% as a guideline. (10% of revenue… So for every $100 in sales, the business ends up with $10 of net profit). There is no golden rule about this number, but it’s a useful guideline in most cases.
Net profit is the money that’s left after all costs of the business have been paid, and you, the owner of the business are absolutely one of the business’ costs, a major one at that. And it’s absolutely right for you to be a cost to the business too, just like the electricity and the rent and the mobile phone bills and the staff. Without you the business can’t function. You are the CEO, the general manager, the head sales person, the chief cook as well as the bottle washer. In any other business, all those people would need to be paid and probably quite highly, and so should you. If you do not pay yourself a proper wage, you’re not professional and nor is your business.
Dribs and Drabs for the boss
I recently started working with a client in an architecture business. The client has 4 staff plus himself and he pays his staff and all his other costs, but he only draws money in dribs and drabs when there’s money left over, and when there isn’t he gets nothing, niks, nada. He showed me his P&L when we started working together, and proudly pointed to the net profit his business made last year. But when I asked him how much the business was paying him, it turned out that he just drew out some money every now and then and that his drawings didn’t show up in the P&L. In effect, if he were to pay himself as much as his lowest paid staff member, he would have made a loss last year. In other words:
My client wasn’t running a business at all, he was running a hobby.
My client has now implemented a weekly minimal wage for himself, run through the books as a wage, showing as a wage cost in the expenses section of his P&L and we’ve updated his business targets to be in line with the new reality. The business is not out of the woods yet, but there is a new air of professionality in the practice and my clients is learning to think like a business owner rather than a hobbyist.
How much then?
The second question therefore is: How much should I pay myself?
Again, it may seem that there is a certain arbitrariness to this question. But the answer is actually quite straightforward:
You should pay yourself as much as it would cost you to pay someone else to take over from you.
Assume you want to go on sabbatical for a year and bring in a CEO to run the business for you… Doing everything you do for the business now… What would that cost? $80K, $100K, $120K? Whatever the answer to that question is, that’s what you ought to pay yourself.
This may well be unachievable right now, (it is for my client… He can only manage about $60K right now), but it’s certainly something you should work towards over the next year or so. It will put the business on an entirely different footing and every time I have introduced this discipline with my clients, the business starts to change completely… guaranteed.