Owner's Pay vs Profit

Businesses are often given the financial advice. “You cannot pay yourself through the payroll process. You'll need to pay a distribution from the profits.”

This leads entrepreneurs to believe owner’s pay and profit are the same.

The advice is true from a tax accounting standpoint. The IRS does not allow most legal entities to claim a tax deduction for owner’s pay.

This is the perfect example of how the advice is true from one financial viewpoint (tax), but hurts your business in other financial ways.

This tax advice ignores other key financial viewpoints that you need to operate a financially healthy business. You need a way to see the true profitability of the business where the owners pay is considered a cost of doing business.

All costs are needed to

  • calculate true profitability
  • set the right prices
  • identify the cashflow needs

The rest of the financial story…

Profit is an accounting concept based on the matching principle. It is simply a math formula - sales minus your expenses.

Profit measures the company's ability to charge the right price and operate efficiently.

Profit is not the same as owner's pay.

Profit does not equal the amount of cash that you have in your bank account.

The flow of money does not stop at the bottom of the Profit and Loss report. Financial commitments are also listed on the balance sheet.

Owner's pay compensates the owner for the services that you provide to the company. Even though you wear a lot of hats, it’s important to identify your primary role and pay yourself a salary based on the fair market value you would pay someone else for that role.

Owners pay is not the same as profit, and it definitely does not equal your bank account.

Keep in mind, businesses only generate money in three ways.

  1. Investments from the owners (equity)
  2. Loans from a bank
  3. Sales from the customers

Eventually, the money from the first two options will stop.

The only way to guarantee you can sustain your business long-term is based on the prices you charge. That’s why it is so important to include owner’s pay and income taxes in the prices. If you don’t, where will the money come from to pay you and the IRS?

Bottom line…waiting for the financial leftovers is a stressful way to operate your business. The key is to be more intentional with owner's pay.

  • Include owner’s pay in your prices
  • Pay yourself on a regular basis even if you cannot pay through the payroll process
  • Ask your bookkeeper to record the payment as an expense so you’ll see true profitability on your operational financial report

This is the quickest way to jump off the financial hamster wheel.


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