Is it Business or an Expensive Hobby?
“Being an entrepreneur, how do I pay myself? Why is everyone constantly talking about splitting business from personal? Isn’t it all mine? How else can I pay my expenses if I don’t draw funds from the business?”
This puzzle comes in because entrepreneurs normally wear two hats at the same time: that of an investor and that of a manager. The best way to separate the two roles is by first understanding the difference between these two:
· investors, as the name says, invest money into businesses but don’t necessarily work there; they deserve a return on their investment or in other words profit;
· managers manage companies without necessarily having to invest their personal funds; for the time and effort they spend working they earn a salary; the salary is paid regardless of the fortunes of the company and must be paid even if a company is making losses; in fact, manager’s salary is a business cost and must be deducted to arrive at the profit correctly. Not taking into account this salary overestimates the company’s bottom line.
If you are an entrepreneur, meaning you work in the company in which you invested your own money, you deserve both: a salary for working and the profit as a return on your investment. (If you want to learn more about the economic theory behind, read here “Are You an Entrepreneur?”.) It sounds like a strange concept to many entrepreneurs who are used to charging their personal expenses to the business account , under the motto “it’s all mine”. But this is a dangerous cycle because you can never monitor the true trend of how your business is doing if you continually draw money. You must separate yourself from the business.
Start with assigning yourself a salary as a manager. As an investor, at the end of each financial period, if business performance allows it, you can pay yourself dividends. But first, you need to determine your salary.
For you to be able to achieve a near accurate amount, you must be as objective as possible. Follow the following steps to help you calculate your salary. You can use our template to help you with this.
1. list all necessary (basic) personal recurring costs that you and your family faces monthly: rent, utilities, food, medical insurance, transport, etc., multiply them by 12 (number of months in a year);
2. add such irregular not-monthly expenses to pay during a year, like: clothing, school fees, vacations, necessary major reparations in the house, etc. Do not include luxuries; salary is not meant to cater for luxury. You can use the profit you earn to splash on a new brand new 72 Inch curved 3D smart TV;
3. add to the resulting amount 10% to 20% on top as a reserve because there are always some unforeseen circumstances. You might be required to pay for a school trip for your children, your car may breakdown and require immediate repair, you may fall sick etc. It is always advisable to have a reserve, meant to act as a buffer for ‘just in case’ situations;
4. Now divide the total amount by 12 — that should be your monthly salary as a manager if you work full time in your company.
Quite a few entrepreneurs are shocked at this point. It’s immediately obvious that they have been paying themselves quite a significant amount, more than they actually perceived. This is part of the eye opener the Advanced Entrepreneurship Program participants immensely appreciate.
Once you have your monthly salary, you can now ask yourself critical questions. Can this business afford me as a manager? Am I able to generate enough revenue to simply pay for my time working in this business? Am I utilizing my time efficiently in my own business? If the answer is no, then it may mean that as a manager, you are too expensive for your business. You might be facing tough choices: either improve productivity within your business that will yield sufficient revenue to cover your cost, or consider hiring a cheaper manager that the business can afford, if you are too expensive for your business. Maybe it is more efficient to split the two roles: hire a manager at a market rate, remain active only as an investor and find employment elsewhere if you being overqualified for your business, are worth more on the job market. You will still enjoy return on your investment in the form of (now increased) profit.
It may come with a pinch of salt, but if your business is to grow, you need to clearly understand the numbers. How much money are you drawing from the business? Without a reference point to how much your business owes you working as a manager, you cannot evaluate if the business is profitable or not. Uncontrollably drawing the money that exceeds your salary simply eats into the capital of your business. This trend cannot be sustainable.
If it doesn’t make money, does it really make sense?
Click here to access our MD Compensation Calculation Template.
