Being a business owner comes with its unique set of challenges and rewards, including the ability to pay your own salary. Unlike traditional employment, business owners have the flexibility to set their compensation based on various factors.
In this blog post, we will delve into various business structures, how business owners can pay themselves, and considerations to ensure fair and sustainable compensation.
Understanding Business Structures
Before choosing the method of paying yourself as a business owner, you have to know first the different business structures in Australia; sole proprietorship, partnership, and company.
Each structure has distinct legal and financial implications, and the chosen structure can affect how owners pay themselves.
Sole Proprietorship and Partnership
In a sole proprietorship or partnership, the business and the owner(s) are considered the same entity for legal and tax purposes. As a result, the profits and losses of the business flow through to the owner(s), and they are typically entitled to draw money directly from the business for personal use. Although, it’s important to note that drawing money from the business does not necessarily equate to a salary.
In a company structure, the business is considered a separate legal entity. As a director and shareholder of the company, you are required to pay yourself through a formal process. This process involves determining your role within the company, establishing a salary, and adhering to legal and taxation obligations.
Methods to Pay Yourself as Business Owner
As a business owner, there are several methods you can use to pay yourself. The appropriate method will depend on your business structure, financial situation, and preferences.
For sole proprietors and partnerships, owners often use the method of an owner’s draw to pay themselves. This involves taking money directly from the business’ profits for personal use. It’s important to carefully track these withdrawals for accounting and tax purposes, as they are not considered wages or salaries.
In a company structure, paying yourself a salary is a common method. As a director and employee of the company, you are entitled to receive a regular salary.
The salary should be determined based on your role, responsibilities, industry standards, and the financial capacity of the business. It’s important to consult with an accountant or tax professional to ensure compliance with legal and taxation requirements.
You may receive income in the form of dividends as a shareholder of a company. Dividends are a distribution of the company’s profits to its shareholders.
The decision to pay dividends and the amount distributed is determined by the company’s financial performance, cash flow, and shareholder agreements. Dividends are typically taxed differently from salaries and wages.
Determining your Compensation
Determining fair and sustainable compensation as a business owner requires careful consideration and adherence to legal and financial obligations, whether you are a sole proprietor, partner, or company director.
To determine your compensation, do an assessment of the financial health and profitability of your business. Evaluate the revenue, expenses, and cash flow to ensure the business can support your desired compensation level. Aim to strike a balance between paying yourself adequately and reinvesting in the business for growth and sustainability.
Industry Standards and Market Rates
Research industry standards and market rates to gain a benchmark for reasonable compensation. Understanding what other businesses in your industry pay their owners or employees can help you determine a fair and competitive salary. Consider factors such as experience, qualifications, responsibilities, and the size and profitability of your business when setting your compensation.
Compliance with Employment and Tax Laws
Ensure that your compensation arrangements comply with employment and tax laws in Australia. This includes adhering to minimum wage requirements, tax obligations, and superannuation contributions.
Seek guidance from an accountant or employment specialist to ensure compliance with relevant regulations and avoid potential penalties or legal issues.
If you are paying yourself as an employee, make sure to inform the ATO and prepare the subsequent deductions, including PAYG tax and super allocations.
Separation of Personal and Business Finances
Maintaining clear separation between personal and business finances is significant for accurate accounting and tax reporting. Use separate bank accounts for personal and business transactions. This separation helps track business expenses, income, and profits accurately, making it easier to determine a fair and sustainable compensation for yourself as a business owner.
At the same time, business owners, especially those running SMEs, cannot just get cash from company accounts as it’s still corporate money. This may raise red flags under the Income Tax Assessment Act 1936’s Division 7A.
Planning and Budgeting
Develop a comprehensive financial plan and budget for your business, including your personal compensation. Consider both short-term and long-term financial goals, such as saving for retirement, paying off debts, or investing in business growth. Budgeting helps ensure that your compensation aligns with your financial objectives while allowing your business to thrive.
Regular Financial Reviews
Regularly review your business’s financial performance to assess the feasibility of your compensation. Analyse revenue trends, profit margins, and cash flow to determine if adjustments to your compensation are necessary.
Financial reviews enable you to make sensible decisions about your salary and adapt as your business evolves.
Seek Professional Advice
Consulting with professionals, such as accountants or financial advisors, can provide valuable insights into structuring your compensation. They can help you navigate tax implications, compliance requirements, and best practices for paying yourself as a business owner. Professional advice can help you make sound decisions and optimise your compensation strategy.
Reinvestment in the Business
As paying yourself a fair salary is important, so is to reinvest in your business’s growth and sustainability. Allocate a portion of profits toward marketing initiatives, expanding product lines, improving infrastructure, or hiring additional staff.
Reinvestment strengthens your business’s competitive position and increases its long-term profitability.
Monitor Personal Finances
Separating personal and business finances doesn’t mean neglecting your personal financial responsibilities. Maintain a personal budget and financial plan to ensure your personal expenses are adequately covered. Understanding your own financial obligations helps you determine the appropriate level of compensation to meet your lifestyle needs.
Regular Compensation Reviews
As your business evolves, continuously review and adjust your compensation strategy. Consider factors such as increased responsibilities, business growth, or changes in market conditions. Regular reviews ensure that your compensation remains fair, aligns with industry standards, and reflects the value you contribute to the business.
DISCLAIMER: This article is for informational purposes only and is not meant to constitute official financial advice. Please consult a business coach and financial advisor.