When you start a business, a key requirement for growth is that revenue be plowed right back into the books. The business, for its part, has to fulfill the need for a steady income befitting your lifestyle.
It’s not easy to balance these opposing requirements, so you have to come up with a clear strategy for splitting revenue into expenses, debt repayment, investment and income.
That’s what this small business income guide is about, to discuss the pros and cons of a small business owner taking a salary vs profit.
|Pros of taking a salary as a small business owner||Pros of taking profit as a small business owner|
|1. Steady income for you and family.||1. You get the financial rewards of entrepreneurship, all the hard work done and the talent you have.|
|2. Fixed expense for the business.||2. Doesn’t show up as an expense in the books.|
|3. Motivates employees that you are one of them.||3. Motivates employees to work harder and ask for a partnership or share of the profits.|
|4. Will grow your business faster than if you took home all the profit every month.||4. You get more money if the business grows and profit is higher.|
|5. Tax benefits as a recurring expense, instead of taxation on dividents or distribution of gains.||5. Tax benefits of profit distribution, based on business structure.|
Sachin Bansal, cofounder of Flipkart, has announced that he paid Rs. 699 crore ($100.3 million) as advance tax for his first quarter earnings, on account of the Flipkart-Walmart deal. If you want to avoid this kind of giant tax bill at the end of the day, you need to make regular draws or distributions to pay yourself.
That raises the question of how much income to take from your small business. While there’s no legal limit in most countries, there is a practical limit in terms of keeping your business operational.
1. Don’t withdraw more than 100% of profits. If you start taking invested operational capital and cashflow from revenue, then the business will soon run out of funding and you won’t be able to pay the bills.
2. Pay all the expenses and debt repayment first. Invest half of the profits for business growth, and take the remaining half as your share.
3. Set a salary and add yourself to the payroll. After all expenses (including your salary), invest the profit back into the business.
4. The simplest and most perfect way to set your remuneration by time spent. What if you had to hire a consultant or employee to do the same job? How much would they charge per hour or day, or for the month? Pay yourself the same amount.
If you want to take home a fixed minimum amount – whether as a salary or profit, then include it in your business plan. Let’s say you need Rs. 12 lakh in annual income. Your forecast for the first year is revenue of Rs. 2 crore, gross income of 50 lakhs and net income of 32 lakhs.
Out of this, you set aside Rs. 20 lakhs to plow back into the business to make it grow faster. That leaves you Rs. 12 lakh for the year, which should be sufficient and steady income for a small business owner. You can take it as a salary of Rs. 1 lakh per month, or a quarterly or annual distribution of 4 lakhs or 12 lakhs respectively.
That may sound simple enough, but the thing to remember is to factor in your need for 12 lakhs annually into your business plan.