Do you take what you need from the company, or take a salary like the rest of your employees? Each option has different pros and cons that can affect your financial health.
Let’s compare the owners' draw vs salary and examine which one is the right option for you.
Owners' Draw vs Salary: what’s the difference?
Your two payment options are the owners' draw method and the salary method.
In the former, you draw money from your business as and when you see fit. You don’t need a salary because you have the flexibility to increase and decrease your draw depending upon your wants and needs.
In the latter method, you take a salary just as any other employee. So as payday comes around you’ll cut yourself a cheque along with the rest of your workforce.
It seems simple, right?
Well, there are a host of extra factors that you need to consider before deciding on owners' draw vs salary. The convenient option for you may not necessarily be the best option for your business, and especially not if it incurs complex bookkeeping!
So let’s dive into the details.
Take out what you want, when you want.
This can include company funds, capital you previously invested within the company, or a combination of both. You can draw at regular intervals or whenever you need it.
For example, if you are a sole trader, then all of your business income is declared and taxes are paid via self assessment. In this case, you don’t pay any separate taxes on your owners' draw as all the money has either been taxed in previous years, or will be taxed in the current financial year.
It is entirely flexible. You don’t pay yourself a set amount because the money can be used at your discretion, and rise and fall depending upon the company’s financial status.
It reduces the company’s funds. All the money that you draw out is tied into the business itself. Every time you take money via owners' draw, you reduce business equity and the potential for business spending in the future.
We’re all familiar with a salary at this point, right?
You, like any employees that you have, get paid a set amount of money for each pay period. It’s that simple. The only difference is that you calculate reasonable compensation for your work efforts and set that as your salary.
The simplicity. You have less admin work to take care of because taxes are automatically deducted from your paycheque. You also have a stable salary, which means that calculating income and expenses become much easier.
You are locked into that salary. A single bad month could lead to burn rate. While there is a tiny margin of wiggle room within your salary, it could swallow up money that your business needs to cover its operating costs.
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When you consider your owners' draw vs salary decision, there is some pertinent information that you should include in your choice.
As you set up your business, you contributed cash, equipment and other assets into your company. Your owner equity is the accumulation of money in the business that has not been spent on the business itself or withdrawn for personal use. Or to make it simple:
Assets - Liabilities = Equity
By calculating the cash, equipment and assets of your company, and subtracting any bills or unpaid accounts, you can view your owner equity of the business.
This is an essential factor for your owners' draw vs salary decision.
Risk of Large Draws
The flexibility of owners' draw can be very attractive, but it can also be a risk.
You have total control over how much you take from the business on a regular basis, and this can include amounts over this year’s profits. Convenient for your mortgage, but not so for your business.
If your owners' draw is too large, your business may not have sufficient capital to cover the operating costs. Your business survives by managing business expenses against its capital. If you withdraw too much owner equity it could severely hamper your business.
Factors deciding owners' draw vs salary
That’s the raw information that you need to know about your decision. But what factors play a part in your final choice?
Let’s take a look.
Why does it matter? Well, different business entities follow different rules when it comes to the owners' draw.
You have total freedom over your company’s money. As the sole owner of the business, your draws don’t incur any tax because you pay tax on the profits of your entire business.
Partnerships / LLP
As a partner you don’t receive a salary, but you do receive your share of the income which you have to declare on your own taxes. However, a partner’s share is not necessarily the same as their equity - so bear this in mind.
The profits belong to the company, not you. The majority of Directors of OMB (Owner Managed Businesses) typically receive a small salary (nominal salary) plus dividends if available.
Thankfully your pay isn’t set in stone, but you must always consider the good of the company first. It’s no good tanking the long term financial health of your business for a single large payout.
Whether you choose owners' draw or a salary, make sure that you only take money from the profits of the company. You should also ensure that you have regular growth to invest in other parts of your business.
Small businesses should always put the business first.
You won’t scale up a business by pocketing the profits you make in the beginning, it just won’t work.
If you are an eager startup, then you should focus on channelling your profits back into your business until you are ready for a bigger payout.
Your family, bills, mortgage, rent, savings or pension fund. These are all understandable costs of living that you still need to cover. You need to carefully balance your company’s need to grow against your need to pay your costs.
To sum up
It sounds like a simple choice, but when you look at the factors surrounding owners’ draw vs salary it becomes… not so simple.
But don’t worry. Just like you are an expert in your business, so too are there experts in this field. It’s why we founded the School of Startups.
Once you’ve done that, you can check out our range of accountancy and finance services for businesses. Our team of professionals offer valuable insights and tools for startups, medium businesses and CFOs. Whether you need bookkeeping software or a hand with those R&D Tax Credits we are here to help.
Simply get in touch with our team of experts and we’ll have something that fits your needs.
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