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Five-minute money masterclass: paying yourself a salary

Written by Dara Jegede on Tuesday, 06 May 2014. Posted in Finance

Of the thousands of entrepreneurs who set up businesses each year, many neglect to factor in the personal salary they need to keep the wolves from the door

Five-minute money masterclass: paying yourself a salary

An entrepreneur might spend the first few months or years establishing and then stabilising their money-maker and, in some cases, will even earn less than their employees at the beginning. As the time to draw a salary from the business materialises, the owner will need to strike a balance between appropriate remuneration and ensuring that extracting a salary is not detrimental to their prized venture. 

Put it in your business plan

“If you fail to plan, you are planning to fail.” Business owners would certainly be wise to take heed of Benjamin Franklin’s words when tackling the issue of their salary. Their business plan should include details of how they expect to pay themselves once the company becomes more profitable and the precise amount they will be looking to take home. “When planning the financial journey of the business, you should be planning out exactly how you might remunerate yourself,” says Michael Bruce, co-founder and CEO of Purplebricks.com, the 24-hour estate agent. 

It will allow owners to easily monitor and maintain a balance with other business priorities. “You need to make sure that when you do your business plan, the prospective cashflow enables you to start drawing some money out,” comments Steve Rees, managing director of Carpenter Rees, the financial services firm.

Make yourself a priority

Many entrepreneurs ensure that everyone else in the business is covered and then they get what is left over, if and when the business is successful. Noble indeed, but the experts suggest turning this notion on its head and prioritising the captain of the ship.

“In order to have a successful business, you have to draw a salary commensurate with somebody who would be performing the job,” says Rees. “Any profit that they make should be an added bonus as a reward for the risk they have taken in setting up the business in the first place.”

Furthermore, entrepreneurs need to do more than just factoring in overheads. “CEOs are there for a reason and carry a heavy burden of responsibility,” says Bruce. “They’re in the firing line and that should not go unaddressed. If the business is very successful, their salary should reflect this.”

Balance business and personal needs 

CEOs should be mindful of not underselling themselves, even though they may not be able to recoup from their business the equivalent of a commercial salary for someone in their position. Bruce believes that the salary should mirror exactly what a CEO impacts within the business. “A good CEO influences every area of business,” he says. “If all’s running well, the salary and package that goes with it should reflect that.”

Owners can also consider other forms of compensation, such as making contributions to a pension arrangement in order to have external wealth growing outside of the business. Whatever the alternative compensation is, Rees says that entrepreneurs need to think about what they want to achieve by drawing money out of the business. “Are they looking to be able to retire early, fund university education or pay for school fees?”

Make your money tax-efficient

Business owners are in a fortunate position that they can manipulate their pay, within reason, to get the best tax advantage. Generally, people in a new business will draw a reasonably low salary and a dividend on top as it is more tax efficient.

“You invest money into the business to get the company up and running,” explains Rees. “The capital injected can be withdrawn rather than drawing a salary because the owner has already paid tax on that capital.” However, one still needs to pay a salary to some extent to ensure that they qualify for state pension.

Rees adds: “Investing back in the business is another reasonable thing to do because as you enhance its value, as long as it’s a trading business, you can then subsequently attract entrepreneurs and sell it.”

Can you afford it?

The last thing any owner would want is to have their salary become a detriment to the business. To avoid this, Bruce suggests keeping no more than five real priorities. “My five are the people we employ, advertising, tech, cash and most importantly customers,” he says. “Cash is king, along with customers, in a launch business”.

Cashflow is vital within a new organisation, Rees says that an entrepreneur has to ensure that the business can afford a generous CEO salary and that they’re not taking money out to the detriment of the business and their customers. “You’ve gotta build it up and be over-conservative in how you take it out,” he says.

“It boils down to being prudent,” adds Guy Mucklow, co-founder and CEO of Postcode Anywhere, the address-finding service. “There is no point in sending your business into a loss-making position and having to take overdraft funding or bank warrants because one insists on having a certain salary. It’s about cutting cloth accordingly.” 

About the Author

Dara Jegede

Dara Jegede

Jegede recently left the London School of Journalism having previously embarked on a soul-searching stint in the city of love. That's Paris, by the way.

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