You’re the Boss. How to Determine Your Own Salary

Sole proprietors often determine their salaries using a
very simple calculation: what’s left over after all
bills are paid is theirs to keep. As a small company
grows and accounting becomes more sophisticated,
however, the financing and debt structure often dictate
that the owner receive a designated annual salary. In
the case of a Bill Gates or a Michael Dell (both of
whom are paid a salary), this figure may be
inconsequential to stock holdings and dividend income.
But for most small-business owners, their salary will
be their primary source of income as their company
develops.

by Jeffrey Moses

When a small-business owner determines his or her
salary, various issues come into play. Because there is
no one set way to determine an owner’s salary, consider
the following:

Profitability of the Company

You can’t pay yourself, or any employee, money that
isn’t available. Assuming that the company is making
more than it spends, your salary should be based on a
percentage of profits over the previous 2-3 year’s (in
this case, some of the previous years’ profits includes
what you have paid yourself during that period). Your
salary should not be based solely on projections for
the upcoming year or years, although tangible contracts
can be taken into account.

What is meant in the previous point by "a percentage of
profits?" Simply that you cannot pocket all profits
because some of your company’s profits must be
allocated to annual increases in marketing and other
operational expenses that grow the business. If an
owner takes all profits as salary, the company runs the
risk of stagnating. A rule of thumb: most owners of
profitable small businesses don’t take out more than 50
percent of profits for themselves.

Compare Your Salary to Others

Many business owners use the salaries of owners in
comparable businesses as a benchmark. Regions of the
country also should be considered, because owners on
the west and east coasts generally pay themselves more
than owners in the Midwest or the South. These are
important factors, but not as important as the actual
profitability of your company. Annual total sales
volumes of other companies are often used as another
benchmark, but actual profitability may have little to
do with total sales.

Pay Your Debts Comfortably

If your company has ongoing lines of credit or other
debt, work with your accountant and your lenders to
determine your salary. Note: lenders tend to be overly
conservative on this point. If your company is
profitable, and has outstanding loans, there is always
the tendency to want to pay off the loans as quickly as
possible. This usually means that you, the owner, must
reduce the amount you take out of the business.
Certainly you will be concerned with the future of the
company, but for your sake — and the sake of your
family — it’s important that you take a comfortable
amount out each year for living expenses. Don’t plow
every penny back into the company at the expense of
your or your family’s satisfaction in life. This
defeats the purpose of starting your own business.

Determine Your Salary Proportionally

The average employee works about 2,000 hours annually.
As a business owner, you may work half again as much,
or more. Consider this when determining your salary.
Example: assume that you and your accountant set your
annual salary at $100,000. This means that if you work
2,000 hours a year, your hourly earnings will be $50.
But if you work 3,000 hours a year, your actual hourly
earnings will be closer to $30. The point: don’t limit
your salary because it seems that your per-hour
earnings are much more than key employees. Your actual
per-hour earnings should be higher than the per-hour
earnings of employees (you’re the owner, after all) —
and because you work more hours, you should take the
greater number of hours into account when determining
your total salary.

Final thought: if your company is set up as a
corporation, you should avoid taking out too great a
percentage of total revenue as your salary. Even small
companies can run afoul of IRS guidelines. Work with
your accountant, lenders, and directors to determine a
fair and reasonable salary, based on guidelines
described above.

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