creative name for your small business

How To Figure Out How Much to Pay Yourself

Gene Marks

You are in college and it is the summer. You decide to paint houses to make a little pocket money. A neighbor of yours is interested. You look at his house and then figure out the cost of the paint will be $500. Would you charge him $500 to paint the house?

Please say no.

The answer is no.

Sophia is a friend of mine. She doesn’t paint houses. And she graduated college a long time ago. She recently opened up a little café located in a corporate center that provides breakfast and lunch. “We have a lot of really nice customers,” she told me. “I’m really happy with how things are going.”

Unfortunately, I don’t think her happiness will last very long.

When I looked at Sophia’s books, here’s what I found: She certainly had customers from the breakfast and lunch crowd coming in. She was paying about thirty cents on the dollar for food, which isn’t bad. The rest was covering her rent and employment expenses. But when the smoke cleared each month, one thing was missing: Sophia! There was nothing left to pay her. She’s the owner, and her café is only bringing in enough to support her employees and vendors. This is not a business— it’s a charity. This is like painting your neighbor’s house and only charging for the paint. There’s only one charity that should be getting Sophia’s money every week. And that charity is Sophia.

Is Sophia starving? No – she’s just living off the salary her husband makes from his corporate job. But if she’s not making any money from her business, then she’s wasting money – money she could be earning doing something more profitable somewhere else. Sure, Amazon and Google and all those other tech firms in Silicon Valley can drum up millions of dollars of losses in the pursuit of building “value” for their “brand.” They’ve got deep-pocketed investors to support them.

But not Sophia.

How much should Sophia charge for a tuna salad sandwich? The answer, of course, partly depends on what the market will bear. Office workers probably aren’t going to pay $20 for a tuna sandwich, no matter how good it is. But other factors go into that price. The cost of tuna. The cost of the roll. And the lettuce, tomato and relish (tuna salad is delicious with a just a hint of relish). But of course those are not the only costs. Each sandwich that Sophia makes incurs overhead – a little bit of rent, the lights, the heat, the salaries of her employees. How can anyone figure out how much to charge for a tuna salad sandwich without knowing all of these costs? Smart business owners don’t just pull their prices from the air. They always start with the final, absolute cost of a product and then apply a mark-up for profit.

And yet, Sophia is ignoring one of the biggest items that make up the cost of a tuna sandwich: That would be Sophia!

So let’s put the market aside for a second and focus on the cost. If, after figuring in the costs for a normal salary, benefits and a profit margin, the price of a sandwich needs to be $1 higher, then she needs to be charging $1 more. Period.

What happens if, after figuring out the cost it turns out that she’ll need to charge $20 for a tuna sandwich? Well, it better be one damn good sandwich (just a reminder – relish will help). Otherwise, Sophia shouldn’t be selling tuna sandwiches. And if all her other sandwiches start coming in at much higher prices after considering her salary she might have to make some other, much harder decisions. Taking a lower salary should be her last choice, by the way. But wouldn’t you rather make these decisions now, before you’ve lost too much money?

Unfortunately, Sophia is not working with all the facts. She’s working on hope. She’s hoping that the business will grow so that it can afford her. Or that by some miracle, profits will rain down from the sky. But successful business people don’t work on hope. They work off of data. They buy for a dollar and sell for three. They don’t wildly gamble. They look coldly at the information, no matter how good or bad, and place educated bets. They are honest with themselves. And Sophia’s not being honest by excluding her salary from the overhead. If you’re not paying yourself, then you’re not working with all of the information you need to place those educated bets. You’re basically painting your neighbor’s house for free.

 

28 Responses to "How To Figure Out How Much to Pay Yourself"
    • David Anderson | November 15, 2022 at 3:54 pm

      Okay, now tell us how to figure out what to pay ourselves. Missed the mark by a mile.

      6
    • Kathy Kramer | November 15, 2022 at 10:59 am

      This article didn’t deliver what the title promised – unless one is a new restaurant owner. I have run my own environmental education consulting business for more than 20 years.

      What I think most people don’t realize are the hidden costs of being a consultant. Say I charge $100 per hour. That sounds great, on the surface. However, I will only have so many billable hours each year – a lot of can’t be charged to a client. (Like billing, marketing, long-range-planning, and other basic administrative work, such as doing taxes.)

      Most people don’t realize that there is a self-employment tax of 7.5% – in addition to the 7.5% tax that every one pays.

      As my husband and I are both self-employed, we get our health insurance through the Affordable Care Act. We’re happy to have it – but for our family of four we pay $20,000 a year in premiums, plus high co-pays, for the cheapest plan available through Kaiser (the Bronze Plan). Two years in a row we spent $10,000 in co-pays – so that was $30,000 a year in medical expenses.

      We also have to fund our own retirements, as we will have no pension.

      Given the title, I had hoped for a more in-depth discussion of what is reasonable to pay yourself than the article delivered.

      11
    • Nina | November 14, 2022 at 1:16 pm

      I was disappointed as I reached the end of the article. Perhaps I was expecting actual guidelines or percentages or formulas to calculate the amount to pay myself. The information is basic and somehow I feel misled by the title.

      16
    • J Slater | November 12, 2022 at 9:21 am

      I was really hoping this was going to help me decide how much to pay myself? If someone has specific examples on what is the best amount based on taxes and reinvestment in the business, I would be very appreciative.

      My business is doing well and could probably pay myself in the 6 figure range. I am trying to figure how much I should be spending on creating new business and if I should be clamping down on travel costs, etc.

      Any help would be appreciated.

      6
    • Paramjeet Kumar | November 10, 2022 at 11:36 pm

      Very informative.

      1
      • Small Biz Ahead | November 14, 2022 at 8:29 am

        We’re glad you thought so! Thanks for commenting.

    • Ms. R | November 9, 2022 at 3:20 pm

      First one or two year of your business, you should not worry about paying yourself. New business is like a plant. You need to give it a time to establish the roots. Once you see your business has solid roots then yes, pay yourself!

      7
    • Thomas Wanner | November 9, 2022 at 2:39 pm

      No pricing formula is perfect, especially when starting out in the food industry. If it was simple everyone would be doing it.

      A menu is a variety of items, where each item will likely carry a different profit margin. Being competitive is a priority consideration in a start up. You first need to appreciate your selling nuance that’ll be a factor in acquiring customers.

      Will it be value via quality, quantity or presentation? Each will affect a different demographic customer base and ultimately effect sales volume. That volume will affect how you distribute your overhead and pricing.

      I’ve known clients who had daily loss leaders but usually made their profits balance with the add ons to the overall sale. Until you know what you’re selling, setting a formula for profit is initially a hit or miss equation. Do it wrong at the onset and you’re likely to undermine the foundation necessary to build upon.

      Salary is an attribute of a successful formula built on the experience of building a successful business. An initial minimum wage is part of the investment into a new business. An ‘ongoing’ minimum wage is part of a formula partial to failure.

      • Small Biz Ahead | November 9, 2022 at 2:57 pm

        Thank you for sharing, Thomas. Very informative!

    • Don Gruenemeyer | November 9, 2022 at 8:50 am

      I will give this to my grandson who is 14 years old. I am sure it will make sense to him.

    • Yolanda Marrero | November 8, 2022 at 1:31 pm

      The article is a good reminder that no matter what business you have started – don’t forget to pay yourself. Doesn’t matter if it’s tuna sandwiches or cosmetics. Figure out what it costs to keep your doors open, then do the math – whatever that math is for your business.

      2
      • Small Biz Ahead | November 8, 2022 at 2:43 pm

        Great comment, Yolanda! Thank you for sharing.

        1
    • Leo Arnenis | March 6, 2021 at 5:44 pm

      Great perspectives! Doing business today versus doing business 30 years ago is day and night. The recipe is 33% food cost, 33% labor and 33% overhead profit. This used to work however today’s reality defers. A lot of expenses sky rocket. Mandatory regulations and unexpected price hikes require overnight adjustments. Measure twice and decide accordingly! It’s getting tougher daily!

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      • Small Biz Ahead | March 11, 2021 at 4:27 pm

        Thanks for sharing, Leo!

    • Laura Pino | March 14, 2018 at 2:46 pm

      Hi graves, see the WikiHow https://www.wikihow.com/Calculate-Overhead

    • Gene Marks | March 14, 2018 at 2:20 pm

      Great comments everyone.

      So how to figure out the true cost of a tuna sandwich? The calculation doesn’t have to be that calculated.

      First, there’s the cost of the raw materials: bread, mayo, tuna, lettuce, tomato and, of course…Philip Franco’s secret relish. You can get granular here. For examples, 2 oz of mayo, based on a 32 oz jar would be $.10. 1 slice of a tomato, assuming a $1 tomato can yield 10 slices is $.10. Right?

      Next…just take the rest of the costs of your restaurant – everything from taxes to salaries (including yours) to rent to utilities to cleaning supplies – for one month. Figure out how many sandwiches in total you’re making a month and divide the two. So if your total restaurant costs are $1,000 for the month and you’re making 1,000 sandwiches then your overhead cost per sandwich is $1.

      I know this is very simple, but this is a small business, let’s keep it simple.

      3
    • Phillip Franco | March 14, 2018 at 10:56 am

      Years ago I owned several restaurants. Customers would ask” what kind of tuna do you use” I did use albacore but you guessed it, relish was my secret ingredient.

      2
    • HVACman | March 14, 2018 at 10:40 am

      Say, $9000 per month was expenses, includes owner basic salary ect. operating hours of 60 per week to sell. $9000/ (60*4)= 37.5, cal it $38 per hour. (sandwich price @ (2.30*3= $6.90) – $2.30= $4.60 , $38/ 4.60= 8.2 or say 9. You had better be selling 9 sandwiches at that cost per hour or 90 of those per day! If not then you are on a sinking ship.
      This is why I usually don’t complain about costs when I’m the customer. Knowing this, you can tell what businesses are run properly. As an owner you will need to make decisions that are difficult. Never cut quality to save money, never take shortcuts. Send employees home early when its slow, negotiate better prices from vendors, open store for longer if it shows it will pay, or even reduce hours that never make money. Maybe Fridays after 3pm there are only 5 customers average. Close at 3.

      7
    • bb | March 14, 2018 at 10:35 am

      Very superficial, I have my own business for over 30 years, what to pay yourself, is a good question.

      What about self employment tax, most new self employed owners never consider that
      healthcare benefits, pensions, other expenses, monthly expenses

      living in NJ the total payroll tax workers comp cost can approach 17% of payroll.

      how to pay yourself, salary weekly, distributions, what about the 179 rules.

      these are just a few issue, to say nothing of the new Trump laws.

      oh what about Insurances other than health and workers comp, liability – personal and professional general, automobile, corporation’s, legal cost accounting costs, audits by the IRS, department of labor, health department. Mandatory donation and contribution to maintain zoning, City rules state rules.

      These can drain you.

      7
    • HVACman | March 14, 2018 at 10:20 am

      Take your set costs in one column add them together. ie, rent, insurance, average cost on utilities, “owners salary”, dont forget advertising.

      second column add variable costs, employee costs, fuel…things that fluctuate quite a bit.

      add them all together. Then divide that number by your operating hours. Now this is a basic way. but you will see what your cost per hour is to operate. Then you need to figure how many sandwiches to sell per hour minus the actual cost of sandwich materials of course. then taxes! It take a few tries then you get into a groove. You could treat it like service and say 5 times cost since you will not sell set number per hour. After all said and done with the math. Whats left is profits an it better be at least 5% after taxes or find another way.

      6
    • Paola Smith | March 14, 2018 at 9:56 am

      Great article! Thank you! Most people don’t know how much it takes to make money from your restaurant/Cafe. Many think the owners make all the money in the world and are taking the priced items straight in to their pockets. Lol.

      4
    • graves | March 14, 2018 at 9:26 am

      We can easily find the cost of the tuna, roll, lettuce, tomato and relish. the cost of the product divided by how many sandwiches we can make from the product. But how do we factor in a portion of rent, lights, heat, and payroll. What is the formula?

      3
      • Margaret | November 8, 2022 at 12:47 pm

        A simplified method might be to take the total cost of rent, lights, heat, payroll, etc. and divide it by the number of widgets (sandwiches) you expect to sell. That’s the overhead cost per widget. The more widgets you sell, the less the overhead cost per widget will be. If you plan on selling only 10 widgets, the price is going to be pretty high in order for you to break even. If you can sell 1,000 widgets, the price per widget can be lower and still result in a profit. Keep in mind that rent, lights, and heat will probably be the same regardless of the number of widgets you sell. Payroll, however, might increase at some point if you need more hands to make more sandwiches.

        1
    • HVACman | March 14, 2018 at 9:08 am

      A good start for people learning is 3x’s the cost of the materials. This will work in most cases.We use it for budget prices and checking bids. There are situations where this does notwork of course, and by no means is it the way to run your business. This is just a tool. the principal behind it is, 33% materials, 33% labor, 33% profit and overhead. Tuna sandwich costs $2.30 would sell for $6.90. You then calculate your operating costs and figure out how many you need to sell to pay the bills. If you need to charge more and you are pushing the limits of what you can sell the product for……..build value or upsell. That’s why you here would you like to UPGRADE to a large for 60 cents more, or would you like fries with that. Ice tea, coffee, fountain drinks are very little base cost but build value to a combo order. You can use this method to check bids, cost of a water heater is $350 an installed price will be 3-5 time the cost. What! where did the 5 come from. In service there is a labor variable. Service techs / and company usually come up with 5 billable hours per day average. Who covers the other 3 hours? Would you work a full time job 8 hours and accept 5? Nope, so its built into the cost. $1750 for a 50 gallon water heater installed sounds expensive…..not when we have to pick it up, install it, dispose of the old unit, pull a permit, come back and wait for an inspector to close a permit.
      KNOW YOUR COST! check your pricing to make sure they match.

      18
      • chet | November 12, 2022 at 11:25 am

        Landscape/contractor businesses run well on the three times principle. Include materials and hourly costs, fuel and vehicle costs. Multiply by three and you should be covered. Example: ten plants at $22 each, mulch 5 bags at $2.50 each. 2 guys for 4hrs at $16-18. Truck costs approx. $200 for 4 hrs. OK 220 +12.5 +128+200= 560. Times 3 equals 1680. Massage number to what the market will bear. You are one of the workers. Sell price $1,500. You have paid yourself in the equation and made additional money(about $900) for unforeseen daily operating overhead. Try to fill each work day with $1200-$1,800 job per day. May incur additional vehicle costs. Margin about 28-35% ok!

        1
    • Lisa Mixon | March 14, 2018 at 1:28 am

      thank for the information i needed it for myself

    • Ana | March 14, 2018 at 1:11 am

      Tks

      • Angelina Pablo | March 3, 2021 at 12:38 am

        Thank you for your time to help me with this information.
        Angelina Pablo

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