Maybe you heard it in passing or perhaps your banker has mentioned it to you? It kind of even sounds annoying don’t you think? Equity…I mean what is it anyways and what has it got to do with anything?
Have you been wondering lately whether or not you can pay your self this week, or month, or anytime in the foreseeable future? Yeah, I thought so. This is it! This is why equity matters.
Hang with me just a second because I have to go “textbook” on you. Equity is the balance of your assets less your liabilities (the accounting equation again).Or in more relatable terms it is what you have invested in your business less what you have taken out (drawn).
Most likely when you were first starting your business you needed to buy equipment or make a website or rent an office, you get the picture. The business hasn’t a single sale yet, and there were start up costs that had to be paid somehow. You either got a loan from a bank, secured an investor, or in most cases you had to use your personal credit card. When you as the business owner put your own resources into your business you created an amount of “owners equity”. Boring!!! I know.
But how do I get paid????
You want to know how to pay yourself from your business and I get that. So here is the meat and potatoes of it all. In order to determine if you have positive equity in your business you need to have a system in place to track your income, expenses, and liabilities. I bet you know what I am going to say next…Yes! You need some form of accounting software. No, it does not need to be complex and I promise it doesn’t need to be scary either.
If you are finding that as a business owner you have blocks surrounding money and finance then I highly recommend finding and awesome bookkeeper to set up your accounting system so you can take over the reins once it has been set up properly. Chances are it is less expensive than you think. Getting started is half the battle, and once you do start it gets easier.
Here’s the thing. Just because your business is making money right now: a) does not mean that you are profitable and b) that what you earn available to be taken out of the business.
Yikes! Sucks doesn’t it?
Okay okay..so how do you know when you can pay yourself? Well, truth be told, you can pay yourself whenever you darned well please. You are the boss! The catch however, is that if your business is not profitable and your bills are piling up you are headed down the path to stress, overwhelm, burnout and event closing up shop.
I don’t like to dwell on the negative so how about we focus on 3 steps you can take to get to pay day.
Manage your Monthly Expenses. Know how much you need to have set aside to cover your basic bills is a great starting point. Try to keep this as a baseline amount in your business chequing account. These are the software subscriptions you can’t live with out, internet, cell phone, and so on. A general guideline is to try to limit your monthly expenses to 30% of your gross income.
Don’t forget the tax man. Knowing how much you need to have set aside for the tax man is challenging. At lower net income levels,(income after deductible expenses) a good starting point is at least 20%, when you are really raking it in this amount may change.
In Canada if you owed more than $3,000 in income tax to the CRA on your last tax return you will get a letter in the mail requesting instalment payments for the current year. DO NOT ignore these, they are mandatory. You can potentially pay less than the requested amount, but you have to be able to prove your net income for the quarter. Now you are seeing why I love accounting software right?
Not to mention sales tax. That money is not yours so best not spend it. Keeping an eye on how much you will owe will help you manage cash flow. Personally I keep a separate savings account just for this. Every month after I review my income statement I also review my sales tax liability and use these two reports to top up my tax savings account. If you aren’t already in the habit of doing this, I highly recommend you start as soon as you can.
Pay yo’ self. Finally! Yes, I know it seems like everyone but you has their hand in the cookie jar but you. When you are a sole-proprietor the government taxes your net income. Which is (in most cases) very different than the cash available to pay yourself. If you have managed to limit your monthly expenses to 30% of your gross income and you are saving 20%, then congrats you now have 50% left to disburse or save for the future.
The term salary is really a misnomer. Employee’s receive salaries which is recorded as an expense. You are the business owner, the money you take out of the business bank account is referred to as a draw. Drawings affect your “equity”, which is not an expense. This is one of the most confusing concepts. When you take a draw from your business it is not recorded on your income statement, it is reflected in your balance sheet.
A word of caution: I cannot stress this enough. Please, please, please have a separate business only chequing account that you deposit ALL of your sales to and pay ALL of your bills from. When your cash flow is flush pay yourself from this account. Let’s not give the taxman any reason to need to go looking into your personal funds (in the event of an audit).
There you have it love. I hope this has solved some of the mystery surrounding how and when you pay yourself. If you haven’t already done so, get to your bank and get yourself a business account. Put it in your calendar right now! Do it!!!
I would love to hear from you. What Wealthy Living habits have you created to ensure that you get paid first?
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