As a business owner, I am sure you have heard of the concept of paying yourself. Unfortunately, based on my experience of working with hundreds of business owners, it’s a concept that many just don’t practice. I believe there are a couple of reasons for this -- business owners feel compelled to put everything back into their business, and they don't track how much money they actually take out of the business.
Those who put all the money they can back into their business often believe they will get a better return on investment than if they had used the money investing elsewhere.
We've all heard the saying that you shouldn’t have all your eggs in one basket. This is true for business. There are a large number of factors -- many of which are outside your control -- that can have a serious impact on your business. These factors can even put you out of business. If you have re-invested everything you had back into your business, and it doesn’t work out, you may be left with nothing.
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When looking at paying yourself first, it will often depend on what stage your business is at. The reality is that you are going to need some money to live off of. This money may be coming out of savings, however at some stage, you are going to need to be able to take some money out of the business.
1. Work out how much it is going to cost you to live.
You want to know that your basic living costs are going to be met. You need to do a personal budget, and make sure that you are going to have enough money to cover your basic living expenses. There is nothing wrong with having two or three budgets.
“Budget One” might be when you are starting your business and can afford to take very little out of the company. “Budget Two” would be when your business is sustainable, and you are able to afford to take a little more out of the business. “Budget Three” is when you are enjoying the lifestyle that every courageous entrepreneur deserves. But take this warning -- I have seen many businesses suffer and fail because the owners have “killed the golden goose” by taking too much money out of the business.
2. As soon as you can -- and ideally from the start -- you should have insurance.
There are a number of different types of insurance and often, you will have to make some hard decisions if you can’t afford all of them. A great rule of thumb is taking out insurance for what you can’t afford to lose. Something often overlooked by business owners is income protection insurance. Think about what would happen to your business and your personal life if you were not able to work and generate an income?
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3. Keep track of how much you pay yourself compared to what would be considered a fair market wage.
Having started a number of businesses myself, I am very familiar with the concept of bootstrapping a business. In other words, not being able to take a fair market wage out of the business. Having done this, I can strongly recommend that you keep track of the amount of money you take out of the business and how much you should be taking as a market related wage.
This difference is what we call “sweat equity.” It is your investment into your business. You are an investor in your business, and all good investors expect a return on their investment. Over time, as your business grows and becomes more profitable, you will be able to take more money out of your business than a market related wage. You will feel even better knowing that you are being rewarded for your earlier efforts where you didn’t take a market related wage.
To recap -- it costs you to live. You want to determine that figure, and track the amount of money you take out of your business to survive personally. As you build your business, it will go through various stages -- startup, expansion, maturity and sometimes, maybe even a decline. Depending on the stage of your business, you can determine how much you can and should pay yourself.
By having both a personal and business budget, you will be able to make better informed decisions, diversify your risk, and have a backup plan.