Payroll may be the last thing on your mind if you are starting your own small manufacturing business - your focus is most likely on making your products and finding a market for them. However, having a strategy for paying yourself is hugely important to your business’s future growth and it’s best to get this sorted out right from the start.
The first thing to consider is how your business is structured. If it’s just you running the whole show, you will most likely be running under a Sole Proprietor setup. There are over 22 million sole proprietors in the United States, making it the most common form of business in the country. Read our article here to find the best structure for your small maker business »
As a sole prop, you don’t need to incorporate or register your business - all you need to do is obtain permits and licenses according to your local legislation and get down to business: there isn’t a lot of documentation involved. You have complete and exclusive authority over your business, which is a massive advantage over other business structures like an LLC or S Corp. For this article on how to pay yourself, we’ll be assuming you are acting as a Sole Prop.
The most important thing you should know is that you are not an employee of your business. Hence, you don’t pay yourself a ‘salary’ per se.
It’s also important to remember that paying yourself from your business is not an expense so it should not be recorded in your bookkeeping as such: this is a really common mistake made by new business owners. Instead, your pay will most likely be recorded as an owner’s withdrawal (known as a “Draw”)
A Draw isn’t subject to FICA taxes, state income tax, federal income tax, or any other filings you provide to the taxman as this is instead calculated on your entire business revenue and expenditure.
How much should I pay myself?
So, as a sole prop how do you go about paying yourself? It’s completely up to you - you might decide to:
Take a percentage of your revenue each week, month or quarter. This approach can be good for situations where you want to increase your takings as the business grows or if your revenue is relatively stable. You can figure out your desired percentage using past financial performance and profit projections or decide on an amount that feels right and allows you to keep enough money in the business for your outgoings.
Take a standard amount that you draw out regardless of your sales volume. This gives you the stability of a wage, however, you’ll want to note that if your revenue decreases, you’ll need to make sure you still have enough cash flow in the business for your outgoings.
Take nothing and reinvest all profits back into the business. This is sometimes a good approach in the very early days for inventory heavy product businesses as it means that owner drawings do not unencumber your business.
The upshot is, there is no specific method you need to follow and you can use any or all of the approaches above as you need. You should take into account your lifestyle factors and living expenses to calculate your desired drawings. If your business is already exceeding your expectations, do not shy away from giving yourself an annual or quarterly bonus, too.
Before you can safely calculate the amount you have left over, you need a system of figuring out your profit margins (the amount you have left over after materials and overheads are removed from your revenue). See How do I calculate my profit margins? for more details.
How do I pay myself?
As a sole prop, you have quite a bit of flexibility in how you pay yourself. Your best option is an automated transfer between your business account to your personal one, as this allows you to keep these transactions traceable and easy to find come tax time. You can also write yourself a check, or withdraw cash directly from your business account via an ATM, or for situations like a craft show where you take cash, you can take your cut directly from the daily takings.
Separate Personal From Business
Without registering for single-member LLC, you’ll want to note that you and your business are not considered different entities in the eyes of the IRS.
You’ll want to avoid paying your personal expenses from your business account, or directly credit any sales revenue to your personal bank account. If you want your business to function as a separate entity, the best approach is to file a DBA (doing business as) and open a new bank account for your business under the same name.
This allows you to see business deposits and withdrawals through bank statements and you can thus separate out your personal finances from your business ones - this is hugely important as it will allow you to see a complete picture of your company finances.