I have followed the debate about business owners paying themselves a salary on several message boards and think it is a very interesting question. Many business owners feel that taking owner draws or shareholder distributions, when they need to withdraw money from the business account, is adequate compensation. Most entrepreneurs work side by side with their employees and frequently put in a lot more time, energy, and effort… after all, the business is their baby, their passion. Most business owners are willing to forego a salary looking toward the time when cash flow is better and the business is on firm financial footing.
Business owners often wearing multiple hats: Owner, Chief Financial Officer, Chief Executive Officer, Manager, Salesman, Bookkeeper, etc. An entrepreneur, as lead person for driving a business to success, must ensure that they are being compensated for your efforts.
The problem with taking draws is that, done inconsistently and without a plan, the business owner can lose control and end up putting the business in a financial bind. Conversely, the business owner needs to ensure that they are being compensated on a regular enough basis to not endanger their solvency or mental well-being. If the business owner feels they are being drained by their business and there is no light at the end of the tunnel, burn out is a danger to attitude.
To determine the compensation value of the services a business owner provides for their company they should research the compensation of business owners from the same niche market in their area. Some business owners find that applying a formula of a percentage of their monthly business profit margin is a good indicator of the compensation they should be paying themselves. Whatever form of calculation provides a usable model, the most important things is to be consistent. Also, remember to work in a raise if business is good. After all, a business owner would recognize and reward the effort an employee made that contributed to business growth. Entrepreneurs are no less deserving of a similar recognition for a job well done.
Once the amount of compensation has been determined then care should be taken to keep the monies separate. Two accounts should be maintained for clarity and ease of accounting; a business account and a personal account.
Finally business owners should discuss the salary verses owner’s draw difference with his/her accountant. There are tax implications and benefits to both ways of paying yourself depending on how your business is set-up (sole proprietor, LLC, etc.)
Please feel free to weigh in with your thoughts and opinions.