How do you assess what you earn as a business owner?
Is it the salary you pay yourself? Or is it the cash drawings you make? Or is it business profit?
What should you base it on and how should you assess it?
Understanding how to analyze your business earnings is really important. If you don’t assess this properly, how can you accurately determine if you are running a successful business?
Market Salary
Regardless of what type of business entity structure your accountant put you into, you need to compare ‘apples and apples’.
Most owners work operationally full-time in their business. So let’s assume that most of you are working in a senior management role.
Regardless of how you take out money from the business for tax purposes, the first step is to look at recognizing a market salary for your operational role.
Your market salary is the salary that you would pay to an arms-length person to fulfill your operational role. For example, if you are General Manager and the market salary you would pay someone else to fulfill that role is $200,000, then that is how it should be assessed.
It doesn’t mean you have to pay yourself the $200,000.
It just means that you should deduct ‘on paper’ a market salary for yourself of $200,000 as an expense to assess your business profitability ‘after your market salary’.
If you have other family members that work operationally in the business; you should analyze profit after deducting notional market salaries for them on the same basis.
Business Profit
So now you’ve assessed your business profit after deducting a market salary for you and other family members working operationally in the business.
Now I want you to look at the remaining business profit as a percentage of total revenue.
Let’s assume that many businesses have annual sales revenue of between $1M and $10M.
For businesses with annual sales revenue between $3M and $5M I like these businesses to earn a business profit of between $300,000 and $500,000.
For businesses with annual sales revenue between $5M and $10M I like these businesses to earn a business profit of between $500,000 and $1,000,000.
These are of course just guides and vary based on size, industry, and margins experienced by your business.
This is, of course, AFTER you have deducted a market salary.
Market salary is what you should be paid for your operational role. This has NOTHING to do with owning a business.
Business profit is the commercial return on the business. This has EVERYTHING to do with owning a business.
I’ve met business owners (husband & wife) that don’t pay themselves a salary tell me that their business makes a profit of $240,000. Upon analysis of their roles, it becomes apparent that their market salaries for key management roles are $120,000 each. When we deduct these two market salaries from the $240,000 they discover that they are actually not making any profit from the business.
They have just bought a job!
Alternately, many of my clients like to draw a market salary and use this for living expenses. They then withdraw business profits periodically for investment purposes. This methodology quarantines money into two categories. One for living and one for investment. This is a Fourth Moon discipline that leverages their success.
Make sure that you are receiving both a market salary for your operational role AND a commercial return for your investment, risk, and skill for owning the business.
And make sure that you haven’t just bought a job.
I really want you to start creating sustainable success in your business and life. Simply check out my FAQs videos HERE on what business owners most commonly ask about sustainable business success. If they help you, simply sign up and get the other 20x videos free.
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Cheers, Darren K Bourke