There is an old saying; 'pay yourself first.'
But, in business, paying yourself first does not mean doing so at the detriment of your business.
For individuals on a budget or living pay check to pay check, it is always good to give yourself a little something each period to avoid job or life burnout, disillusionment or to reward yourself for continued diligence.
Not so in business. In business, the entire premise is to take risks and make sacrifices as the ultimate long-term rewards (i.e. financial freedom and personal wealth) are the result of these actions. While individuals may be forced to work to fund their lifestyles, business ownership is purely on a volunteer basis and thus comes with additional costs.
More times then not, budding entrepreneurs think that their new business should not only turn a profit the very day they open their doors but should immediately bleed off vast amounts of riches the business owners can take out of the company for personal use. This is far from what actually happens and thus results in a tremendous amount of unnecessary business failures.
Further, many entrepreneurs simply attempt to start businesses in hopes that they can earn huge paychecks from day one. This only results in wasted time and money and never results in success of the business or in the hopes of the business owner.
Most businesses will take 12 to 18 months before they break even. Further, after this time frame, even if the business is turning a profit, any profits should be returned to the business to be used for growth and expansion - called 'plowback.'
Plowback is the cheapest way for businesses to finance their growth. The goal is to leverage those unencumbered funds to generate even more revenue and thus more profit - (that is the goal isn't it?). As this process happens period after period, there will then become a point that the business is generating more in profits than those profits can generate in new business.
It is at this point, this marginal level, that business owners can start looking to pay themselves. Anything less or taking money out of the company any time sooner is just plain bad financial policy and will result in either failure or in the business not living up to its full potential; essentially short changing the business and those that took the risks to get the business up and going in the first place.
Business, by its very nature, is simply taking assets and employing them in such a way to generate the greatest return. If assets in the business are not being deployed in the most beneficial manner possible, then they should be taken out of the business and placed in whatever vehicle that will return the greatest amount of reward - this relates to assets like time and personal energy as much as it relates to monetary assets.
A quick example: ABC LLC is generating $10,000 per month in net income and has no debt. It plows back its net income and by doing so is able to generate an annualized 15% return on this equity. After the first year, this business's profits would be $130,211 - for its second year, $281.354 and for its third year, $456,794. Had it not plowed back these funds, its three year profits would have only been $360,000 (a near $100,000 decrease) and without the growth in the business and without the potential for future growth in both revenue and net income.
This does not mean that a business owner cannot be compensated for their time and efforts in salary or wage. But this:
1) should not be done because the business owners needs cash to fund their lifestyle or are in financial distress.
2) should only be done when the business is at breakeven or profitable. If done before, the business owner is taking funds earmarked solely for business development and growth. Most of the time, development funds can be very expensive to the business either in the form of high interest rates and fees from loans or by giving up ownership stakes in the company via outside equity investment. Further, if these funds are from personal savings, then the business owner is merely taking back their own funds and if done under this scenario, these funds should have never been placed in the business to begin with - just think about the possible tax implications!
3) should only be taken at a level consistent with the duties being completed by the owner. Example, if similar, non-owner managers in your industry are earning say $4,000 per month - then this is the max amount the business should take from the company (a fair compensation for their work).
If these are not followed and more is taken for self-satisfying reasons, it will only hurt the business, can cripple the operations or hinder any ability to take on new opportunities that materialize.
The goal in business is to grow the business to the point that it can financially bleed off wealth for the owner(s). But, if the business is not given the opportunity to do this to it maximum potential, the business owner is effectively taking potential money off their own table.
Thus, if, as a business owner, you want to pay yourself, you are better off doing so last, or at a point that it is the most beneficial, than following that old saying of 'paying yourself first' or, in the end, your business may not pay you at all.
About the Author:
Joseph Lizio holds a MBA in Finance and Entrepreneurship, is the founder of Business Money Today, has a strong commercial lending background and is regarded as an expert in business and finance.