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Systemize your owners’ bonuses for more predictable cash flow

by | Dec 11, 2021

There’s a variety of reasons why you may’ve become an entrepreneur and started your own business. You might’ve wanted a better work/life balance, more flexibility, to be your own boss, you were laid off, etc. But, money is always part of the equation. (You have bills that have to get paid, after all.) And, running your own business can be farrr more lucrative than being an employee. You can pay yourself a higher salary, deduct certain eligible personal expenses, make larger retirement contributions, and, one day, hopefully, sell your business. But, in the short term, the most lucrative perk is owners’ bonuses, draws, distributions, and/or dividends (aka the amount you earn above and beyond your salary).

But, most businesses (until you have an in-house finance team) don’t have a system or process for taking owners’ bonuses. You’ve found systems and processes for your invoices, bill pay, savings, salaries, etc because you had to. They might not be ‘best practices’ but there’s still systems there that work for you and your business. On the other hand, owners’ bonuses are usually taken whenever. Whenever there’s extra cash in the bank, whenever you’ve landed a big new client, whenever you want to take a vacation, etc. And, while that might not be a hugeee problem if you have a proper salary and savings, randomly taking bonuses makes it almost impossible to cash flow forecast or strategically plan because it’s very difficult to plan around “whenever 🤷‍♂️ I don’t know.” And, if you don’t have a proper salary and savings in place, it creates a whole slew of cash flow problems. (Check out this issue from a few weeks ago where we discussed the problems disorganized cash distribution can cause.)

 

It’s a bonus :

It’s a bonus. You’ve earned it by working hard and running your business. But, it’s still a bonus and you should treat it like one. Don’t treat it as an extension of your salary. As you become used to it, your personal expenses will slowly increase to match it (this is commonly called lifestyle inflation). And, that can be a problem if you ever have a small business emergency (for example, a large client leaving, a series of less profitable projects, etc) and need to cut back on your bonus, but can’t due to your personal expenses. It can turn a small problem into a much bigger one.

 

Tie it to something:

Your bonus should be based on somethinggg (as opposed to withdrawing however much feels right). When it’s based on something, you can make sure you don’t accidentally pull too much money out of your business. For example, if you’re trying to expand, you can set your bonus as 20% of the prior quarter’s profits. You’ll get a bonus and won’t have to worry about ‘what if I took too much out?’

Examples:

  • a flat annual bonus based on your compensation/salary (eg a Christmas bonus, a busy season bonus, etc)
  • a quarterly bonus based on a percentage of profits
  • a quarterly bonus based on hitting important personal targets like getting new clients, profit over a certain level, or your own utilization (utilization is the ratio of billable hours to total working hours)

 

Take it at regular intervals:

Your bonuses should follow a regular and predictable cadence. That could be quarterly, semiannually, annually, or something in between. The exact cadence you choose doesn’t really matter. You’re just trying to make it predictable, so you can account for it in your cash flow forecasting, strategic planning, and personal finances. And, even if you aren’t doing intensive forecasting or strategy, a regular and predictable cadence will help smooth out your business cash flow.

(Note: I don’t really recommend monthly because then it becomes an extension of your salary. Quarterly is infrequent enough that you won’t plan monthly expenses around it.)

 

Talk to your accountant before taking a bonus:

I’m using the phrase ‘owners’ bonus’ very colloquially here to mean an owners’ distribution, draw, and/or dividend in excess of your salary. Depending on your legal entity (or lack thereof), your bonus may have to be paid out in different ways and you should discuss your specific situation with your accountant. And, if you run your own payroll (for example, through Gusto or Quickbooks Payroll), do not casually run a ‘Bonus Payroll’ for your owners’ bonus or distributions. That will make your owners’ bonus subject to payroll taxes and, while employee bonuses are always subject to payroll taxes, there may be a more tax-efficient way for an owner to take their bonus.

(Note: This is based on the US tax system.)

 

Action Item:

 

Decide how often you’d like to take bonuses and what you’ll tie it to. (Quarterly and 20% of profit is a perfectly good place to start.) Then, set a recurring calendar notification to remind yourself.

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