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How can entrepreneurs decide how much to pay themselves?

Posted by Shivali Anand

October 25, 2021    |     4-minute read (736 words)

Most entrepreneurs make sacrifices and receive little or no monetary return on their path to success. Although it's common to forgo a salary when starting a new business, it's fair to begin paying yourself after your company has reached profitability, as opposed to reinvesting every penny gained back into the company. The rationale is simple: It's your dream, and you should be able to enjoy the benefits of your effort. 

But how much should you be compensated as a founder? This is an age-old problem. You should be able to choose the size of your paycheck since you own the company. While the idea of establishing your pay seems fantastic in principle, it may be a difficult decision to make in practice. 

According to Y Combinator, a founder's pay should find a balance between increasing their capacity to concentrate on the startup while lowering the business's burn rate. According to the IRS, the salary you receive as a corporate officer should be proportional to your responsibilities. So, think about these suggestions to come up with fair remuneration for yourself.

Find out how much money you make each month

Calculating your company's net income guarantees that all of its costs are covered. After deducting your business's costs from your gross sales, you're left with net income. The formula for determining net income (monthly) is:

Net Income = Gross Revenue – Expenses.

 Consider your tax liability

 The next stage is to calculate how much tax you will owe. This is critical because if your company generates a profit, you will have to pay taxes. But how much capital do you need to set aside for taxes?

 A good starting point is 30% of your net income. Your tax percentage may be more significant if you have partners or are in a higher tax bracket. When it is about taxes, it's best to consult with your accountant since they'll be able to offer you a more exact estimate. We'll use 30% as an example for this example, in which case the tax liability would be:

 30% x net Income = tax liability (approximate)

Subtract this amount from your net income to get a general idea of how much money you have to pay yourself. Let's refer to it as "net cash." So:

 Net Cash = Net Income – Monthly Tax Liability

 Don't forget about business debt.

 It's now time to think about your business debt (assuming you have any). Begin by calculating your total monthly debt payments, which will include money borrowed from a lender, loans, and credit card charges. Keep in mind that the interest on your loan may be tax-deductible. To calculate your "gross pay," subtract your monthly debt payments from your net cash. Hence:

 Gross Pay = Net Cash – Monthly Debt Payments

 Make a forecast of your future business requirements.

 Consider your long-term objectives before paying yourself. Determine how much you'll spend on new equipment, product development and launches, new hiring, and other expenses in general. Subtract these costs from the previous step's total to arrive at the amount you may take home as a wage. Therefore:

 Money You Can Pay Yourself = Gross Pay – Savings for Future Needs.

 Preferably, examining this figure will help you determine how much you should be able to pay yourself each month, but if it isn't enough to cover your demands, you may fiddle with the figures. However, company expenditures, debt payments, and future savings may all be negotiated, but not taxes. Remember that you don't have to pay yourself the whole amount - you may figure out how much you need to survive and only take that amount if required. However, this figure is a good starting point for determining what wage options are open to you.

 Owner's draw method or salary?

The next step is to find how you'll pay yourself after talking with your accountant and establishing how much money you should accept. Depending on the form of your firm, you can pay yourself as an entrepreneur using one of two typical approaches. You may pay yourself a regular salary or take a percentage of your profits as an owner's draw. You can consult with your accounting staff to determine which is the best option for you.

 One of the most significant pros of starting your own business is being compensated for your efforts. Whatever amount and method you choose, make sure you complete your study so you can afford to pay yourself regularly.

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