One of the most common mistakes a working small business owner makes is the failure to take a consistent wage for the labor they perform to generate sales and earn a profit. They are too comfortable deferring wages for themselves when cash is tight and then wonder why their spouse is frustrated with them when there is no money to buy the things needed at home.
The best way to ensure you are charging fair prices and paying attention to the costs of the business is to pay yourself a living wage. Your goal is not to overpay yourself for your day-to-day contributions. Your big payday comes through your Equity decisions. Your goal is to pay yourself a fair wage for the time, talents, and effort you bring to the business when working as an employee “in” the business, not an owner “on” the business.
Overview
A business owner who is a big part of getting the work done in a business must pay themselves a fair wage, or you’re subsidizing your customers by allowing them to buy from you without the value of “you” built into the prices you charge. Don’t do this.
No business owner should ever allow themselves to make below minimum wage after dividing the monies they take out of the business by the hours they spend working there. To protect yourself from doing this, you must know what your Owners’ Compensation Ratio is relative to how much Net Income your business produced.
The Owners’ Compensation Ratio divides the Net Income by the total wages, benefits, bonuses, and payroll taxes a business owner pays themselves for the work they perform in the business. The Owners’ Compensation Ratio does not include equity distributions or owners’ draws. These are Balance Sheet transactions reflective of the business owner, whereas the wages they take for the work performed should be treated as a cost of doing business.
Business owners who consistently pay themselves a fair wage, are seen to have consistently better cash flows, higher Gross Profits, and better Operating Income than those who choose not to pay themselves fairly.
The formula for calculating your Owners’ Compensation Ratio is as follows:
Net Income / Total Owners’ Compensation
A ratio of 0.05 means that for every dollar of sales, the owner is paying themselves 5 cents on each sale. A 0.01 ratio means that for every dollar in Net Profit generated after everyone has been paid, the owner pays themselves $0.01 for every $1.00 sold and collected.
Higher Creates Opportunity: the higher the number, the more the owner recognizes through their compensation, the value they represent to their business.
Lower Creates Challenges: the lower the number, the less the owner is paying themselves to work in the business, or they are not carrying their weight as they should.