How To Pay Yourself When Cash Flow Is Random
When I was building my second startup, I got into a never-ending cycle of not paying myself — every month, I’d pay off my monthly subscription for my website, accounting software, and any outstanding invoices, and then not pay myself because only $50 was left over, and what’s the point of paying myself $50?
I then continued this process every month, denying $20 and $100 amounts left and right, dreaming of the day when I’d receive that $1,000 paycheck to pay myself (I know, dreaming big). I didn’t understand at the time that my $1,000 paycheck was already flowing my way, it was just broken up into 30 little paychecks.
I had a naive perception of startup cash flow back then — I believed that cash flow would flow in predictable, sizable chunks between the 1st and 31st of every month (without any structure or systems to make that happen).
I held on to the idea of receiving a check every two weeks as if I worked as a full-time employee at an established business — that was my image of what paying myself looked like, and I didn’t understand that I had to amend that image to the reality of working at a startup.
Here’s the truth about the early days of building a business, specifically in the pre-revenue or in-the-thick-of-creating-revenue times — your cash flow will be all over the place until you nail down your revenue model and actually get it to work in the real world.
Receiving a paycheck as if you’re working as an employee of your company will not be your norm for a while — there is a startup-specific method of paying yourself that’s a bit different from what you’re used to and requires some setup to make happen.
While you’re receiving sales sporadically here and there, I recommend setting up a system so that you can still get paid. Here’s how I go about it —
1) First Thing’s First: Dividends
Before diving into how you can create a system to pay yourself, I first have to explain what dividends are in this context.
Many small business owners take dividends as their take-home pay when they’re first establishing the business and haven’t hit steady-enough revenue yet to set up payroll.
Dividends are what’s left over after you’ve paid off all of your expenses for your business (dividends are paid out from your company’s profits). You still have to pay taxes on dividends (federal and state), so I strongly recommend that you calculate all your numbers appropriately so that your take-home pay includes the tax payments you have to make. This link provides a great reference on how much in federal taxes you have to pay on dividends according to your projected annual income.
Dividends are what we’re going to assume you’ll be relying on for your take-home pay for the rest of this exercise.
2) Budget Yourself Into Your Pricing
Your Desired Dividend:
In order to pay yourself a predictable amount, you have to budget yourself in.
Map out all the monthly expenses for your business + your desired dividend for each operating month and factor that into your product or service pricing.
After crunching your numbers, you may find that you have to slow down the pacing of your spending or cut out some expenses in order to make your desired dividend, this is totally normal and a good exercise to put yourself through.
For product businesses — After doing these calculations of what your pricing should after your desired dividends are added in, it’s very normal that your pricing may get inflated above market prices.This is where you have to make a decision —
1) Are you willing to take a cut in your take-home dividends temporarily so that your product’s prices can be competitive in the market (until you eventually hit scale and a pay cut will no longer be necessary)?
2) Or will you look for external investment or a side-hustle to provide a take-home dividend boost while the business is gaining its footing?
In order to do all this math correctly for pricing adjusted for dividends, you also have to know how much you’re projected to bring in in monthly revenue. This is where things get tricky because your monthly revenue will either take a bit of time before it hits some traction, or there will be a lot of up and down fluctuation in your numbers.
Due to the unpredictability of revenue, I recommend that you base your numbers on the minimum revenue you know that you’ll hit every month.
Do not base your calculations on your expected revenue. Starting a business requires patience and time, and basing your numbers off of expectations rather than your reality will just stress you out since so many things will be out of your control. Your assessment of how much in dividends you can take home should be realistic so that you can plan your personal finances accordingly.
3) Percentage Structure
After you’ve budgeted your dividends into your pricing, it’s time to create a percentage structure. I have to credit Mike Michalowicz who wrote Profit First for this idea — it’s simple but brilliant.
Based on the projected revenue you’ve determined in the step above, you will be using that to create a percentage structure that you’ll abide by every time you get paid.
Let’s say you anticipate that your business’ minimum monthly revenue will be $1,000 and that your desired monthly dividend (including taxes) is $500.
This means that your monthly dividend ($500) represents 50% of your monthly minimum monthly revenue.
With the remaining 50% that’s left over for the month, you should divide this amongst your business’ expenses. So the final percentage structure for your business’ minimum monthly revenue may look like this:
Minimum monthly revenue: $1,000
My Dividend: $500 (50%)
Business Monthly Fees: $200 (20%)
Virtual Assistant: $250 (25%)
Business Profit Fund: $50 (5%)
Now that you know what your percentage breakdown is for your monthly revenue, you now know how you have to divvy up every single payment that comes into your business.
So when you receive a $50 payment, you have to set aside 50% of it for your dividend, 20% of it for your monthly fees, 20% of it for your virtual assistant, and 5% for the business’ profit fund.
By the end of the month, this will all add up so that you definitely get your $500 dividend, and are still able to pay your business’ monthly expenses.
4) Make It A Habit Or Automate It
The key to paying yourself pre-payroll is to make it a habit. Paying yourself in multiple transfers/checks is unconventional compared to the bi-weekly paycheck way, but it’s the way a lot of startup founders have to do it. Adjusting your take-home pay strategy to the cash flow reality of your startup is necessary so that you get compensated while running your business.
Set up your business’ pricing for success and create a percentage structure so that the math adds up for you to get paid your dividend every month.
Set up a calendar date 2x a month where you have to sit in front of your bank accounts and make the dividend transfer according to your percentage structure or automate it through your bank. Whatever method you choose, make it a habit!
This system has helped me consistently hold a profit for my business for the first time in years, pay myself regularly, and pace my spending to the cash flow speed of my business. The percentage structure is a great regulator if you don’t have a CFO to ping you when money is tight and to warn you of overspending. I recommend following this system regularly for a solid 6 months to see and reap the full benefits.