Why taking a small salary blurs what is ‘actual’ net profit

A couple of weeks I came across a small business owner that was flaunting their 20% net profit margin, and shared they were just crushing it! What I have come to find when peeking behind the curtain, I could quickly see what was making their net profit look so good and what was causing their income statement and balance sheet to give this false reading.

Why do I say this…

Many times here is what is happening, the business owner is usually paying themselves a small salary, maybe $30,000 or less annually. Then they are taking another $45,000 in distributions that are showing on the balance sheet.

Here’s what’s really happening…

The business owner might be patting themselves on the back and saying their doing great with making over 20% net income of sales. However, this is all skewed because the owner is not paying themselves a market based wage. In business we get paid for what we DO while working in the business, and receive a return on their investment for what OWN as the investor.

If we were to correct the income statement by adding the low salary and the distribution together and adding this back into salary/wages on the income statement, we quickly would see that the business may be barely at 5% net profit and is one bump away from going out of business!

Lastly, if you are not paying yourself a market based wage in your business, then when the time comes when you want to hire someone to do your job in the business; you will never be able to afford it. This is because you could never hire someone to work the 3rd world wages you may be paying yourself (I’m joking of course).

Be sure to keep all of this in mind as you are setting up your salary and what you are taking out as distributions. This can be quickly become a slippery slope.

Feel free to connect with me: todd@simplebackoffice.com. My staff and I are here to help you grow your business with a profit.

Todd A. Lay
SimpleBackOffice