Welcome to the next lesson of the Start-up School! We are delivering some very simple lessons which you’re going to read about, sit down and go ‘uh, yeah, why didn’t I think of that?’ – except for this lesson because this lesson is pretty much about the reason why you’re starting a business in the first place.
So, without beating around the bush (and creating unnecessary dramatic tension), I present today’s lesson:
Pay Yourself!
Duh. Obviously.
By paying yourself I don’t mean blowing money on a full-day complete body care and makeover at your local overpriced spa – I actually mean:
You. Pay. Your. Self. Money.
Money from your business. Money which we have just discussed in the previous lesson belongs to your business.
“But, Sam, didn’t you just teach us that our business’ money is our business’ money! Not our money??”
Yes, absolutely true, and you should always remember that! But I’m not a hypocrite (most of the time) so let’s take some time to clarify why and how you need to pay yourself.
In every business that ever existed since the age of modern accounting, there has been a transaction called the almighty ‘Drawings’ which business owners use to pay themselves.
No, not drawings like the silly drawings that accompany articles on this blog – I mean drawings as in drawing (taking) money out of the business for personal use.
Now basically every business owner ever will take some money from their business. Which is fine… except that some business owners treat their business like their personal ATM and don’t leave anything in there to pay for business expenses!
The key to managing your drawings is to pay yourself an amount of money from your business on a regular basis (Weekly, Fortnightly, Monthly, etc.). Think of this money as compensation for the amount of time, work and effort you put into your business. Ultimately, the business is there to serve you, not the other way around.
It’s common for new start-up owners to martyr/sacrifice themselves for the business – working long hours, not paying themselves, etc. However this approach can cause burnout from excessive stress and pressure, which is a very real and very major cause of business failure. If you don’t take care of yourself, who is going to take care of your business?
In determining how much drawings to take to pay yourself ask yourself the following questions:
- How much can my business afford to pay me?
- How much can I get paid for the work I do for my business in other similar industries?
- How much do I need to live comfortably?
Let’s take the example of Ahmed – Ahmed is a designer who has set up his own design, media and marketing business. He’s been building up his street cred and networking hard for the past three months and the results of his hard work is starting to show as he made sales worth $4,000 this past month.
Now, out of that $4,000, he still needs to put aside 30% for taxes (remember the previous lesson?), which leaves $2,800 for the business. Ahmed has monthly expenses of about $800 relating to his internet connection, website hosting, advertising and networking – that leaves about $2,000 profit for this month.
Should Ahmed pay himself $2,000?
Ahmed asks himself the following three questions:
- How much can my business afford to pay me? – To be honest, not much. If I took all the $2,000 I’m not leaving enough in the business to pay for any unforeseen expenses
- How much can I get paid for the work I do for my business in other similar industries? – Media design jobs don’t always pay very well – I’d be lucky if I can get $30 an hour for the work that I did.
- How much do I need to live comfortably? – By comfortably, meaning enough to get by? I can probably squeeze by on $1,000 a month to pay rent and groceries – after all i’m flatting with 4 other people (saving me heaps on rent).
Ahmed eventually decides to pay himself $1,100 through drawings – to cover his living expenses and a little bit more. This means $900 is still left in the business for future use.
From a tax point of view, drawings are usually non-taxable, meaning you don’t have to pay any personal tax on drawings you take for yourself. However, it is important to remember that drawings are not expenses instead they are treated as a form of asset or negative liability that gets recorded in the balance sheet of the business.
Too technical? Ok, to keep it simple: Drawings are not business expenses and will not decrease your business’ profit – meaning that you will still have to pay taxes on whatever profit is generated by the business even if your business bank account has been emptied into your own pockets (don’t do it!!!). By the end of the day, you still have to pay taxes. Sorry, but there is no escaping that fact of life!
So there you have it! Lesson 2: Pay Yourself!. Make sure you are disciplined about it and don’t take too much! Only take what you need.