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7 min read

How much should I pay myself as a business owner?

You started your business to secure a greater level of financial freedom. You have an ideal income goal in mind, and you’re working hard to achieve it

The question is, what’s the best way to pay yourself as you grow your business? How much do you pay yourself on a monthly basis while making sure you’re as tax efficient as possible?

In this article, you’ll learn a formula for calculating your fair and reasonable salary and how to reduce your tax bill at the end of the financial year.


Video: Should I register as a limited company or a sole trader?

by Informi

This video explains the benefits of trading as a limited company, explaining the differences between sole traders and limited companies and the various ways that a limited company can protect small business owners and inspire confidence in their businesses.

What about dividends and payroll?

As a business owner, you’re also able to pay yourself a dividend. These can amount to any value, as long as they’re taken from your company profits (meaning everything after your operating expenses and taxes).

While payroll is usually set in stone every month, there are no rules around how often or how much you can pay yourself in dividends. However, it is best practice to pay yourself regularly in order to avoid withdrawing intermittent lump sums that could raise concern with the government. Plus, depending on your business structure, you may need to receive business owner wages on the standard payroll. 

We recommend you talk to your accountant about the best way to approach your payroll and dividend payments. This way, you can ensure that whatever method you pursue is compliant with government regulation and recorded effectively in case the tax authorities ever audit or investigate your business finances.

To summarise, the way you pay yourself depends on the legal structure of your company. If you’re a sole trader, you have more leeway. As a company director, you must take payroll and dividends into account.

Create a director salary schedule

While there’s some flexibility around sole trader income and director dividends, it’s important to create and stick to a salary schedule.

By determining what you’ll pay yourself on a monthly basis, you can accurately forecast your business’ profit and loss. Furthermore, a salary schedule makes managing your personal finances easier.

Using accounting software to set up regular payments for yourself (and your employees) on a monthly or weekly basis. Include these amounts in your forecasting and business plans. Make room to increase your salary and dividends as you grow your business.

Not only does this create predictable cash flow, but it helps you to avoid a potential tax investigation for irregular or unlawful dividend payments. While there are no laws that state how often dividend payments can be processed, HMRC may take action if they suspect there is not sufficient profit to cover the payouts. 

As it’s not uncommon to accidentally overpay dividends based on revenue instead of profit, it’s best to meticulously track your company finances and stick to a predetermined payout schedule.

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Pay yourself a reasonable wage

For startups, a common approach is to “pay yourself enough to get by”. In the early stages, many founders decide to minimise their personal income in order to invest more in the growth of their business.

As you generate revenue and report on positive cash flow, you can increase that amount based on what the business can support. Depending on how young your business is, there are two ways you can calculate how much to pay yourself:

1. Pay yourself enough to meet living expenses

Even the most ambitious startup founders need a roof over their head. As you begin to generate revenue (or venture capital), ensure you’re paying yourself enough to meet your basic needs.

This means bills, rent or mortgage payments, food and other expenses (such as transport). If you can afford some non-essentials (like that morning coffee from your favourite barista), then make room for them in your budget.

To figure out exactly how much to pay yourself on a monthly basis,  follow these steps:

  1. List out all of your personal transactions over the last three to six months.
  2. Identify essential transactions (rent, mortgage etc.) as well as an estimate for food and other variable costs.
  3. Calculate your monthly revenue and subtract your company expenses to get a basic net income value.
  4. Set aside tax savings, business debt and money that you want to invest in business growth.
  5. Subtract everything you’ve set aside from your net income and you’ll end up with your minimum monthly income. 

If this number is less than what you need for personal expenses, you’ll need to make some adjustments for what you are able to immediately save for future business growth. Play around with the numbers until you land on something that makes sense for both your personal and business aspirations.

2. Your reasonable wage

With minimum income calculated, the next step is to figure out your reasonable wage. This can be a subjective exercise and can greatly depend on what the market determines is a fair salary for your efforts. 

Many business owners started their own venture to achieve more financial security. As you pursue your goals, monitor the market trends to determine a baseline salary and then multiply that using the rate of inflation as a compass.

To do this, start with your hourly rate or annual salary for the day-to-day tasks required to deliver products and services. For example, if you’re running a design agency, you might start with your hourly rate as a freelance designer.

If your hourly rate is £45 an hour and you work eight hours a day, five days a week, your monthly market value would be £7,200.

This amount only determines your value based on skills or market output, not your day-to-day role as a business owner. To calculate your true monetary value, take this monthly amount of £7,200 and multiply it by three to four times the inflation rate

It’s important to take the inflation rate into account because as the price of goods and services increase, wages must be evaluated alongside it. Otherwise, as the prices of goods and services naturally increase, your salary will remain stagnant and lose value, thus decreasing your purchasing power. 

At time of writing, the inflation rate in the UK is 3.2%. If you wanted to pay yourself three times the inflation rate, you would multiply your monthly rate of £7,200 by 9.6% (which is three times the rate of inflation) to give you an extra £691.20 a month.

As a result, your annual salary goes from £86,400 to £94,694.40. 

To summarise, here’s a formula to calculate your basic worth as a business owner:

(Market Worth / 12) * (Inflation * N) = Inflation Value

Market Worth + (Inflation Value * 12) = Basic Worth

This formula allows you to accurately calculate your annual salary as a business owner. Bear in mind this doesn’t include bonuses you pay yourself based on business profits.

How to ensure tax efficiency

Now that you know what to pay yourself, how do you withdraw it from the business while being as tax efficient as possible?

The answer to this question will depend on the legal structure of your business (among other factors). One option is to balance your summary with dividend payments. By withdrawing a portion of your basic worth as salary and the rest as a dividend, you can keep your personal income tax to a minimum when self-assessment day comes around.

In order to pay yourself a dividend, you first need to ensure that you have sufficient profits to legally do so. Then, you must fill out a tax voucher, which is simply a statement noting the dividend amount paid out and the person it’s being paid to (yourself). Lastly, file the tax voucher and the minutes with HMRC. At time of writing, the tax-free dividend allowance is £2,000. 

Some business owners prefer to take payment in stock options or create an agreement to defer payment until a later date. These approaches are more feasible for those who have been in business for some time, as they rely on cash flow and the overall value of the business as an asset.

If you’re unsure what the right approach is for you, speak to your accountant. They’ll be able to take a closer look at your finances and recommend the right approach for you. You can also use Informi’s self employed tax calculator to give you a rough idea of how much you’ll need to set aside for tax. 

Figuring out how much to pay yourself needn’t be a mystery. Take into account your monthly expenses and what your business can afford. Calculate your basic worth based on market value and inflation, and implement a payment schedule to keep your bookkeeping squeaky clean.

Ready to make business banking easier?

A Tide business bank account can make the process of paying yourself and managing your business finances much easier. 

Open a business current account with Tide and Informi and get £50 on us to get you started.

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