How much can you afford to pay yourself?
When you are hired by a company, one of the most important things you need to know is what salary you’ll be paid. But how can you work this out when you work for yourself?
Too many business owners work for free, or almost free. Or they take a salary from what is left in the business when everyone else has been paid.
Sometimes this is necessity – especially if you are just starting out. But often it occurs because of one of two reasons:
- Your expenses are eating into your profits and there’s not much left for you
- You’re not focused on paying yourself
The Profit First method prioritises your pay
The Profit First method helps business owners to escape from this trap by flipping around the usual formula businesses use for accounting and, literally, putting profit (and your pay) first:
- So, instead of this formula: Sales – expenses = profit
- The Profit First uses this one: Sales – profit = expenses
The principle behind it is that, rather than wait until your business has paid expenses to see what is left in the pot to pay the business owner, the business must run on to what is left over after the business owner has been paid.
This doesn’t mean – before you panic – that you are encouraged to take as much as you want from your business and, only then, try to pay your bills! Instead it focuses you on the concept that there should be profit in your business, both for you and to keep in the business for future cash flow and investment.
To enable this, you need to keep a tighter rein on expenses than you may otherwise have done.
Why it’s important to conduct an expenses audit
And there’s good reasoning behind this. I find that as businesses grow, their expenses often grow with them. Suddenly they can afford a bigger office, better software, new laptops etc. And rather than their profits growing as they scale, they see their profit margin shrink or stagnate.
The Profit Method helps stop this by making you consciously decide how much of your turnover should be assigned to expenses. It also ensures you keep a much keener eye on your outgoings.
When I mentor businesses, I usually get them to conduct an expenses audit. (You can find out how to do one here.) It’s very rare that there aren’t places they can cut back, either by eliminating costs that aren’t necessary, or by finding cheaper ways to achieve the same results.
How to work out how much you can afford to pay yourself
So how can you work out how much you can afford to pay yourself using the Profit First method? First of all you need to know what your turnover and expenses are. If you’ve been tracking your monthly profit and loss, this should be quite easy (you can download our free spreadsheet for this here.)
If you haven’t been tracking your monthly profit and loss, you can go back through the last three months’ bank statements to get an idea of your numbers.
Once you have these figures, you can take a stab at your tax liability, and from that identify what you have left over for your pay and retained profit – this is money you keep in the business. For the Profit First method you need to calculate your percentages for the following:
- Your profit
- Your expenses
- Your tax
- Your pay
Once you have identified these percentages, it’s easy to work out how much you can afford to pay yourself each month.
I recommend using our free Profit First calculator here – it makes it really quickly and easy for you.
Why you need to pay yourself
When you follow the Profit First method you must pay yourself something every month – even if it’s just £1. It’s the principle of making a profit and paying yourself that counts.
This flips your perspective from feeding a hungry machine that demands more and more expenses to run, and instead ensures you are fed first. When you are starting out, this will be a modest amount, but as your business grows and becomes more profitable, so you your salary can increase.
You may also find yourself in the position of being able to invest some of your business profits into a pension. Not only can this start building a healthy nest egg for your future, but it can also help to reduce your Corporation Tax bill. (You can learn more about pensions and tax breaks here.)
Apart from anything else, you work hard on your business, so don’t you deserve to enjoy the rewards?
