Salary vs distribution
How much can I pay myself?
- 50% of your revenue goes to owner compensation.
- 15% goes to taxes (including business taxes and personal tax on business income).
- 5% goes to profit – every quarter, pay yourself half of this balance as a profit distribution, and leave the rest as a cash cushion.
- 30% goes to operating expenses.
Example
This concept is much easier to understand with an example. For this example we’re going to start with revenue for the last 12 months – even if last month was really great, you need to look at your historical average so you account for ups and downs, and don’t base your plan on your high income months only.
Ralph’s Landscaping brought in $120,000 in sales in total for the last 12 months. Target allocations for the whole year are:
- 50% owner comp = $60,000
- 15% taxes = $18,000
- 5% profit = $6,000
- 30% expenses = $36,000
Ralph decides to pay himself twice per month. For owner comp, Ralph is going to set his annual salary at $60,000 based on his allocations, which equates to $2,500 per bimonthly pay period.
At Ralph’s next money meeting, he reviews his deposits and finds that he made $6,000 in sales. He then allocates his money to four buckets:
- 50% owner comp = $3,000
- 15% taxes = $900
- 5% profit = $300
- 30% expenses = $1,800
Since Ralph has $3,000 in his owner comp bucket, he has more than enough to pay himself his $2,500 bimonthly salary. Yay! He leaves the remaining $500 in the account. That way, if he has a dip in sales prior to his next money meeting, he has some cushion and can continue paying himself a regular salary.
He also has $300 in his profit account, so at the end of the quarter, he gives himself $150, or half, as a profit distribution. He leaves the rest in the account to use if crap hits the fan.
The next quarter, Ralph runs his new 12 month numbers, and updates his allocations based on his latest average revenue. If revenue is up, he gives himself a raise!
In Summary
Definitely read the book. I found the writing to be very informal and easy to read, but I think the principles are easy to implement if you start small and improve your allocation percentages over time. And no one can complain about actually paying themselves!
- Make it a goal to pay yourself a regular salary and quarterly profit distributions.
- Set target allocation percentages that work for your business. Try to improve them over time!
- Always pay yourself first, even if you can’t pay yourself as much as you’d like right now. Start small, and work to become more efficient with your operating expenses so you can increase your pay over time.
- Set up a regular money meeting with yourself to review your financials and transfer your deposits to your owner comp, tax, profit, and expense buckets.
And if this system sounds good to you but you aren’t confident you can implement it on your own, contact us to discuss how we can help you implement this system as part of a monthly bookkeeping plan!
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