Why small business owners can't afford to underpay themselves

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People start businesses for myriad reasons. It could be that they are following a passion or wish to take control of their lifestyles and schedules. Perhaps there's a level of demand for their products or services.

Also, unlike working for a boss, you are not dependent on others to either run the show or pay you for your efforts. At the same time, you have the flexibility to decide how much effort you'll put into your business and, hopefully, how much you'll earn.

Still, the primary contention many owners face is the size of the pay packet they can take out of the business.

why small business owners cant afford to underpay themselves

Unfortunately, it appears many SME owners aren't paying themselves enough, according to business coach Suz Chadwick. Through her research, Chadwick has discovered that around 45% of the small business owners fail to pay themselves enough - if anything at all.

She says the reasons owners aren't paying themselves a decent wage varies from "I'm not earning enough to pay myself regularly" or "My client load changes, so I pay myself what I can."

Others, according to Chadwick, fail to pay themselves because of fluctuating cash flow. Ironically, 74% of the owners she surveyed consider that they oversee profitable business - so go figure.

Business adviser Craig West, CEO of Succession Plus, says business owners often fail to pay themselves, either first or at all, for various reasons.

"The most obvious is cash flow. When times are tough, they pay suppliers, rent and bills and then find there's not enough money to pay themselves at the end of the month.

"Sometimes it's tax-driven, where they need to pay themselves a low amount to stay under a certain tax threshold. And sometimes it's simply a desire to reinvest in the business to help drive its growth."

Anne Nalder, founder and CEO of the Small Business Association of Australia, says SME owners generally don't pay themselves because they can't afford it.

"Also, some take drawings when money is available rather than reporting it as a wage."

Small business is doing it particularly tough in lockdown locations, notes Nalder.

"Owners are trying to survive and therefore struggling to pay themselves. Their fears are well-founded as there is uncertainty with little clarity.

"Australia is being run as eight separate countries. The fear is genuine and consists of health, including mental health issues, lack of incoming revenue, the possibility of losing their homes or failing to comply with regulation due to their business barely surviving."

Impact on the value 

Regardless of why SME owners may decide against taking a pay packet, this has severe consequences for the value of the business, warns West.

"If you are not paying yourself a market salary, then a buyer will expect this money to be added back when they determine what your business is realistically worth. In many cases, businesses that look profitable but rely on the owner and often their family as free labour are not profitable at all."

West says it is critical to treat the owner as an employee and separate ownership, or equity, from employment, or income.

"For example, when you do the monthly pay run, the owner should be included at a market salary, the same as every other employee. If this is not achievable, then something is fundamentally wrong with the business's financial performance and needs its cash flow to be addressed first."

Using accounting software and professional advice to predict and manage cash flow is also valuable, says West.

"Xero, for example, has recently released a module to help businesses see their forward cash flow and hopefully avoid issues like not being able to pay the owner an income."

The accounting platform's short-term cash flow tool takes all the relevant data from your bank accounts, bills and invoices to give you an up-to-date view of your cash flow in one place. Using this data, Xero estimates your bank balance 30 days into the future.

The tool can also show you the impact of existing bills and invoices if you pay them on time.

Using Xero's tool, an SME owner can determine which invoices should be chased up and how cash flow changes if you pay a bill this week or postpone it for a period of time. This strategy might also help free some cash to make sure there's money to cover your next pay packet.

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Anthony O'Brien is a small business and personal finance writer with 20-plus years' experience in the communication industry.
Comments
Stella Young
December 11, 2021 11.26am

Fine in theory, but for businesses in Victoria the sovereign risk is massive.