As a Business owner which is better Profit or Wages?
I am often asked this question:
Should I pay myself more, or take extra profit from the business?
The best way to work out the answer is to start with some definitions:
Profit is the reward for taking the risk of investing in a business
Wages* are the reward for the your time and expertise you contribute to your business
*NOTE ABOUT WAGES – for this article I am using “wages” to mean pretty well everything you pay for from the business, prior to paying company tax, that gives you a benefit; any salary, superannuation contributions, drawings, personal expenses, perks and Fringe Benefits Taxable expenses etc, that you take out of the for yourself or your relations.
Taking Profit or Wages
So, how do your Wages and your Profit fit together?
As business owners we undertake 4 kinds of activities for our businesses, and we deserve to be paid well for every one of these:
1. Worker – doing stuff; serving customers and clients etc
2. Manager – coordinating stuff; making sure things run to plan and the timing and quality of goods and services are up to scratch
3. Director – deciding stuff; creating the plan, look and feel of the business including business strategy, and future directions
4. Owner – investing stuff; providing the backing, guarantees, and money to start (and often grow) the business
Often our accounts, and year-end reports are set up in such a way that it is very difficult to clearly identify what is being paid as a return on the investment and what payments relate to time. Messing the two up doesn’t really matter until you want to actually assess if you are getting enough, or if what you are taking is reasonable, i.e. if you don’t really care if your business returns less than you could get elsewhere.
On the flip-side, identifying and tracking what you contribute, and if you are being appropriately rewarded, enables you to assess the true costs and benefits of investing and working for yourself and compare those costs and benefits with investing and working elsewhere. This also means you can therefore assess if, and how, taking more out of the business is appropriate, or if the business needs to be generating more so you receive sufficient returns for all your investment and hard work.
8 Steps to Taking Wages and/or Profit
Wages – Calculate Time Reward
Step 1 – What do you Do?
It might be hard to actually work out exactly how much time you spend wearing each of the above four hats daily, or during a single week. BUT if you look back on the last year, overall, you can most likely work out a rough average that splits up how you spend your time…
Step 2 – What are you worth?
Take these rough averages and for the time split from Step 1 and establish what you would pay someone else to do the worker, manager and director roles for you. Don’t forget to include overtime, sick leave, holiday pay and all the other benefits that your staff get (the things you most likely never take). The calculation should show less for worker wages than manager wages, and a bit more for director wages – added together this will constitute a competitive Wage for your overall time.
NOTE: Think about it in terms of if you were sick what would you need to pay the three part-time people needed to fulfill each role in your absence?
Step 3 – What is appropriate?
a) Measure what your current Wage is by adding up what you receive from your pre-tax business profit each year in drawings, perks, superannuation, salary etc… You don’t have to show anyone but yourself so be extra honest and include all those “Bunnings” purchases you took home “accidentally” and any “business lunches” you might have had – don’t under-estimate the rewards you really take by leaving this out.
b) Compare what you take in Wages against what you are worth from Step 2 above.