3 ways to measure the impact of your salary on your new business.
Do you want to launch your own business to do something you love while earning money? How much money should you pay yourself? Too little and you may personally struggle to make ends meet. Take too much and your business could also struggle.
Finding the right balance is crucial to the success of both entrepreneur and enterprise. Once you know the salary you need, it's time to balance that figure against your business' finances.
While there are no fixed rules about owner compensation, follow these steps to measure the impact of your salary on your new business before you even launch it.
1. Calculate your personal budget
Take the time to figure out exactly how much money you need from the business on an annual basis. If possible, use a past tax return or dig up expense receipts to identify your personal costs. Work with someone close to you to produce realistic figures.
Include these items in your budget:
- Mortgage or rent payments
- Car and public transportation costs
- Utilities, insurance, and service fees for television, telephone, and internet
- Clothing and personal grooming
- Groceries and sundries
- Vacations, entertainment, and dining out
- Childcare costs
- Credit card or other debts
- Dental and medical fees
- Personal savings
Don’t forget about taxes. As a salaried employee of your business, you will pay income tax. Check with your accountant or consult the Canada Revenue Agency (CRA) website for current tax rates.
Be as accurate as you can. Underestimating personal expenses is one of the biggest mistakes a new business owner can make. If you slip into the red, chances are your business will, too.
Let’s say you’ve calculated that your business must pay you a salary of $50,000 for the first year, including taxes. You can now apply this number to your projected financial statements to see if business income will support it.
2. Check your projected income statement
Take the figure you need for a personal salary and plug it into your projected income statement for each of the first three years of your business.
Review the spreadsheet to carefully assess:
- Impact on profit: Does the salary figure put your overall numbers in the red? While it’s natural for a new business to report minor losses during the start-up years as it struggles for profitability, major losses (such as $50,000) may be too much for your small company to absorb.
- Hiring: Will paying your salary prevent you from hiring employees?
- Other salaries: If your company has other founders or managers, is your salary in line with their compensation? Significant disparities may cause rifts.
The best advice is to review your projected income statement and salary expectations with an accountant. They can help you to decide what the business can reasonably afford to pay you, and provide recommendations to minimize any tax implications associated with your compensation.
3. Test your salary in your projected cash flow
You'll need to check the cash flow projection in your business plan to ensure that you have enough money coming in to cover your own salary and other operating expenses.
Plug your proposed salary into your monthly cash flow spreadsheet to see how the numbers change.
Ideally, your cash flow will have a surplus large enough to pay your desired salary every month, comfortably cover operating expenses (e.g. loan payments, office rent, employee wages, telephone service, office supplies, and advertising) and leave a little margin for error.
Before you take action on any of the information above, we recommend consulting with a qualified business advisor that understands your unique needs and situation for your specific business and/or personal plans.