Myths of Contracting: Not drawing a salary and living off the profits is the responsible thing to do
"The blunt truth is if you don’t bring pricing discipline to your company, you are asking your family to provide the buffer"
By Robert Koci
By Steve Ryan
This is part of a broader myth that too many company owners believe, that the things they do for themselves don’t have a cost to the company. We’ll look at that broader question in a future entry but for today we’ll focus on whether you should pay yourself a salary (or wage).
When a contractor defers their own compensation until they can draw a “dividend” from company profits it probably feels like the responsible thing to do. If they can avoid committing to the overhead expense of their own salary the business stands a better chance of being profitable. Here’s the reality though. If your business can’t support the cost of a fair and reasonable salary for the general manager (you) then your business is losing money.
Why does that matter so much? Well you may have seen an early entry in this series that cautions you to factor all of your costs into your pricing decisions. In other words, you can’t simply look at your job costs as the threshold between profit and loss on a job. You need to recover enough to pay overheads as well. If your own compensation isn’t counted in those overheads your pricing decisions will be made using flawed numbers.
Well that’s the finance guy’s point of view at any rate. So let’s look at the question from the business owners point of view. You may feel that cutting your own compensation out of your company’s operating costs provides flexibility. If you counted it as a cost you would have to commit higher profit margin on your work, and higher break even sales volume. Paying higher costs adds pressure to generate invoices, and to collect against those invoices. Why would anyone choose to take on that added pressure?
The answer to that boils down to one word…”Discipline.” If you aren’t willing to apply the discipline to cover all your costs, then you probably won’t. Now here’s where it gets unfair. The blunt truth is if you don’t bring that discipline to your company, you are asking your family to provide the buffer. You reduce the pressure on your company budget by overlooking the cost of it’s general manager. But that pressure just transfers to your personal family budget through irregular or erratic personal income.
You may not look at things this way, but you should start to view yourself and your company as two distinct entities. From a financial standpoint, you can and should be compensated as an employee for the work you do for your company. Does that mean you should forget about profit? Absolutely not. You should manage your company with the objective of generating a profit. Now look upon your income on two levels. Your company pays you as an employee. That’s not discretionary. Over and above this, as your company earns a profit, this can also come to you as a dividend.
In wrapping up let’s dispense with another myth. Would lenders and/or investors not be impressed by your cost control and the lower overheads you can show when you don’t draw a salary? In fact, it is one of the first things they look at. When an entrepreneur fails to pay themselves, it looks amateurish and timid. If you can only show promising financial projections by working for free, that is not a place where lenders or investors want to take a risk. If you want to impress investors or lenders, demonstrate that your company earns a profit even after it has paid its general manager.
For most residential contractors, the biggest obstacle to success is rooted in being unaware or misinformed regarding the basics of running a business. They have the skills to run building projects. Not so much for running their business. MMI Professional Services is committed to the success of contractors by helping them develop the business and management skills they need . For information on ways to run a better building business contact the writer at email@example.com