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Paying Yourself

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Look at the Books Before You Pay Yourself

Before you go paying yourself, know your business books well. How much money is coming in? What expenses do you need to budget for? One bookkeeping tip is be sure you accurately record any withdrawals of money removed from your business for personal purchases. Do this whether you remove a flat salary or some percentage of the earnings or some more complex withdrawal. In fact, if you haven't already done so, open a separate checking account for your business. This is essential for you to know how well your business is doing. You want to know how much money your company earned before compensating yourself for your service and work within the business.

Next, you also want to know how much you've received as personal compensation for your efforts in the business. To know how well you're doing, you must be able to distinguish between business expenses and personal expenses. By accurately recording all your income and all your expenses, you see how much your company earned. That amount should compensate you for your time and effort in running the business (and hopefully, make you wealthy!).

For the Record. . .

Paying yourself as the money comes in is usually a bad idea. This is because the earnings and cash flow of operating a company aren't exactly correlated. For example, maybe one month you bring in $1,000 from sales. You pay the money to yourself and buy an expensive new sewing machine and a bunch of new fabrics. Then the next month, you receive a bill for $700 for materials you used last month. Ouch! You didn't allow for that! So now, you have to come up with $700. Projecting cash needs in the future is often called "cash budgeting." Another possibility is just listing the expenses you know you have incurred to date (money you will owe in the near future) and those expenses you will incur in the next few months (for example, for rent). Then, be sure you retain at least this much money within your company. How much money you must leave in your business is dependent upon how much money your business needs to cover your current and near-future expenses.

Set Aside Growth Funds

Plus, you'll often want to retain capital to launch new products or marketing initiatives. I think it's a good idea to always allocate some money just for growing your company.

Don't Forget About Taxes!

One expense many business owners miss in the "paying yourself planning" is taxes. As a business owner, you're responsible for paying taxes on your profits. You usually must make estimated tax payments to the IRS (and state revenue departments) on your earnings.

(For more info on estimated taxes go here)

Unlike most expenses, taxes are only incurred when you show a profit. But showing a profit is only a function of your revenue and your expenses. So when you brought in $1,000 and incurred a total cost of $700 to do so, you earned $300. If taxes are owed on this $300, be sure to budget or set aside some money for that obligation as well. You don't want to find that you did great last quarter earning $10,000, but then realize that you now owe $3,000 in taxes to the IRS you haven't retained. So planning and cash budgeting is crucial.

Once you have a handle on how much your company earns regularly and what your regular costs are, you'll invariably have a good idea of how much money should be retained within your company. Finally, some investments which you make for the future growth of your company will be tax-deductible in the current period. Pre-tax dollar investments in future growth are usually superior to after-tax investments. Another option for sheltering income from taxes is to start a tax-deferred retirement plan for your business, such as SEP-IRA.

Hope this helps, Stephanie!

Peter Hupalo

Author of Thinking Like an Entrepreneur

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