Underpaying yourself as a new business owner can damage your company, even if it may be tempting during lean months. Here’s how you can pay yourself and stay in the black.
Nearly half a million new businesses were registered in 2020 in the UK as a result of COVID-19 redundancies triggering people to set up on their own.
“Sweat equity” is the idea that owners shouldn’t pay themselves a salary while they’re building their new business, but the inability to pay yourself is a red flag that your business is not working. So, as a new business owner, how do you calculate how much to pay yourself?
Business finance experts, Bionic, have put together a simple calculation to work out how much you can pay yourself whilst keeping your business afloat and thriving, along with specific advice for different types of businesses.
How much should I pay myself?
As all businesses are unique and business owners’ circumstances differ, this is a hard question to answer with definitive figures, but this should give you a rough idea.
On the one hand, 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. Entrepreneurs will often take a basic wage to simply cover living expenses in the early days, as this is a way to ensure the business has maximum investment while reducing the amount of start-up capital needed.
To do this, you need to work out your basic worth.
How to work out your basic worth
Take your basic worth (the minimum you want to make when going into business).
Divide it by 12.
Multiply the rate of inflation by 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
Unfortunately, it’s not enough to simply break even, and your priority should be to make sure that your business is financially stable.
How to tie your salary into your business’s growth
If your business grows by 5% over a quarter, then reward yourself with a quarterly wage bonus of the same amount, as below:
Take your monthly wage.
Multiply it by 3 (number of months in a quarter).
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 you can arrive at a figure when working out how much you should pay yourself. The above are simply suggested methods.
When can I increase my salary?
Again, every business is different, so there is no one size fits all answer to this question. The obvious answer would probably be that you can increase your salary when your business breaks even, but even this comes with some caveats.
It’s not enough to simply break even, and your priority should be to make sure that your business is financially stable. This is because every inflated overhead will impact on the overall cash flow of your business, and so paying yourself more when it’s not financially robust enough can have a negative impact on growth.
To avoid this happening to your business, it can help to tie your salary in with your business’s growth.
You should then reassess your salary annually, based upon the growth and performance of your business. But, above all, remember to be realistic with your wage, and make sure it’s financially sustainable for your business.
How do I pay myself as a sole trader?
If you’re a sole trader, then all profit earned is yours. Using this money is classed as “business drawings”, and is different from taking a wage. On the downside, you are personally liable (you have unlimited liability) for your tax bills, so you need to make sure 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.
If you are a sole trader, it could be worth setting up a separate tax savings bank account and aim to deposit up to 25% of all net income. Then, at the end of the tax year you’ll pay a self-assessment bill. You should speak with your accountant on whether you need to have another bank account for your VAT.
How do I pay myself as a limited company?
If you are a limited company paying yourself, things work quite differently because you are an employee of the company, even if you are the sole employee.
In this instance, it might help 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 earn more, then you need to register yourself as an employer at the government website.
From there you will receive two letters 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 GOV.UK for more information on setting up and running a payroll.
As you can see there’s a lot more to consider when deciding how much to pay yourself as a business owner, other than the figure that you will be bringing home every month. You should also take into account the tax implications that your monthly wage has and, most importantly, whether it’s financially feasible for your business to support the wage you want.