Three simple steps to pay yourself as a business owner

(pay yourself – 5 minute read)

One of the questions that I get asked frequently is this:

“As a business owner, how do I pay myself?”

It’s the question that every new business owner has asked me over the years. So much that we have come up with a simple intuitive system that we like to call ‘Pay Yourself’. I’ve written about it in greater length before (you can check out the article here). This piece is a quick summary for readers who don’t have the time to read the whole article in full.

Pay Yourself works based on three simple steps:

Pay Yourself #1: Establish your monthly baseline expenses

Comic Sam is dropping from the top of the frame but he lands in a pile of cash that he's put aside. He says: Phewh! I'm glad I had this pile of cash to land on!

The first step is to work out how much you need to run your business on a monthly basis. These monthly expenses include the cost of buying stock, paying wages, servicing rent, paying for power, etc. As a business owner you should have a rough idea of how much it takes to run your business. If you are not sure of how much it costs, you should really look at using an accounting software, like Xero or MYOB to help you. If you are using accounting software, it’s very easy to pull up an expenses report to tell you how much you spend on a monthly basis.

Take your monthly expense figure and multiply it by 1.5. This gives you a 50% buffer against unexpected occurences. Once you have established your monthly baseline expenses, you should ALWAYS ensure that in your daily spending account (have you setup your business bank accounts yet?) you have this amount, at a minimum!

For example

Your monthly spend is $3,000 a month and that includes wages, rent and power. $3,000 times 1.5 is $4,500. This means that your bank account balance in your daily spending account should never go below $4,500. The only situation where you you can go below this amount is if you need to put money aside for taxes.

Pay yourself #2: Put aside your taxes

A picture of a massive wall safe with signs saying: STAY AWAY!; Don't Touch!; 4 Tax and a sign with Steve The Reapers which says 'He's Watching'

Once you’ve established that you have enough money to cover your monthly baseline, you need to put away money for taxes. Remember that you’re not an employee on PAYE (pay as you earn) tax deductions! You have to put away your own taxes now. If you are GST registered in NZ, you need to put away money for GST as well.

Saving for GST

Have you set up a bank account for GST? If you haven’t, you should! Before you can pay yourself, you need to make sure that you have put 15% of your income for that period so far in the GST bank account. Here’s how it works:

You have made $8,000 of sales for the April to May GST period. You work out GST payable of $1,200 (15% times $8,000) to put away in your GST account. Make sure that you transfer money from your daily spending accounting into your GST account so that you have this amount!

Note: we’re not taking GST claimed on expenses into account here because we want to keep things simple!

Saving for income tax

As with GST, I hope you’ve setup your income tax account as well. For this type of tax, you need to work out how much profit you’ve made for the financial year so far. With an accounting software, this is very easy to work out. If you don’t have one, you will need to work out how much income you’ve made on the business and how much expenses you can claim on that income (remember how to claim tax expenses?). Your profit is your income minus your expenses. Then multiply that amount by 28% (which is the corporate tax rate in NZ) and make sure you have that amount put aside. Here’s how it works:

Your profit for the year so far is $10,000. Before paying yourself, you need to make sure that there is at least $2,800 (28% of $10,000) sitting in your income tax savings account. If there is not enough, you need to top it up with funds from the daily spending account!

Pay Yourself #3: Check your balances and pay yourself!

A giant green disembodied hand labeled 'Your business' is holding a big brown sack of money over a Wide-eyed, sparkly eyed, drooling man in a red shirt who is labeled 'You'

The last step is to make sure that:

  1. You have enough money set aside for monthly expenses
  2. You have enough money set aside for taxes

Once you’ve confirmed that, you can now Pay Yourself! Basically, you take a look at whatever is leftover, after putting aside money for monthly baseline expenses and taxes. For example:

You have already set aside $4,500 for monthly baseline expenses, $1,200 for GST and $2,800 for taxes. You now have $5,000 left in your daily spending account. Congratulations! That $5,000 left is all yours to keep. You can withdraw this amount as drawings. This amount is tax-free, because you’ve already put aside the income taxes for it in step #2.

I don’t recommend taking it ALL out though. It is best to pay yourself enough to match your current market rate. If you are unsure, just take enough to cover your personal living expenses. If you have any leftover after that, put it aside in your fuel for growth account for future business expansion!

All good to go?

There you go: a simple 3 step way to pay yourself as a business owner. Just remember that Step 1 and 2 are more important than Step 3. In fact, there may be times you won’t have enough money to complete Step 3. But so long as you keep Step 1 and 2 in check, you can be sure that you are managing your business cashflow well!

Leave Comment

Your email address will not be published. Required fields are marked *