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Take Home Pay Vs. Retaining for Future Growth
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Last month, First Bank’s John Harrington, Western Region Senior Credit Analyst, continued his insightful series with a discussion about the factors that go into determining how much business owners should pay themselves. In short: business owners should balance their pay with the capital needs of their business in order to grow. In this new article, John digs deeper and provides the top three questions a business owner should ask themselves before determining what they should pay themselves.
Q1: What are the goals for growth?
Rather than blindly deciding what to do with capital, every business owner should start by determining what their aspirations for growth are. Is it simply being able to hire someone one day to do the job for you or do you have long-term growth plans to become a regional brand?
The ultimate size a business owner wants to grow their company to has a direct impact on both the amount of capital needed to be retained and the time needed to retain it. It may be possible for a small company to double in size in the next 12 months, but to grow into hundreds of employees will usually require several years of discipline.
Q2: What needs to be saved for and what can be financed?
Not all growth goals need to be funded with cash. First Bank is here to help and may be able to provide financing to help get you there.
Say a part of your growth plan includes purchasing a building, allowing your company to build equity within the property rather than continuing to pay rent. If you need a $300,000 building, that doesn’t necessarily mean that you have to save up that much capital. For example, if you were to secure financing for 75% or even 80% of the cost, you could adjust your savings goals accordingly. Instead of saving $300,000, now you just need to save $60,000. This drastically shrinks the savings timeline and frees up a greater proportion of capital along the way to be spent on other things.
Q3: When does growth become not worth it?
At a certain point, it stops being worthwhile to grow. Economists call this diminishing returns.
As a business owner, you need to evaluate how big and complex you want your company to be. Would you be happier managing an office team of 30 that effectively serves only your immediate community or would you want to grow to 200 employees across three states? How big can the company grow before you get overwhelmed and the increased cash flow stops being worth it? The answer differs from owner to owner and is worth considering as you set your goals.
Key Formulas
Factoring these three questions into your plans will help you plan the monthly amount of capital retention that can build the needed equity in the correct timeframe. Any cash flow over that amount is what you could pay yourself.
While this exercise does not have to be repeated monthly, it is worthwhile to evaluate your growth goals and the allocation of your cash flow frequently-at least yearly-to make sure that you are still enjoying the maximum return from your business. A formula for this concept of financial management is provided below.
- Capital need for growth goal / Time = Capital retention plan
- Cash flow – Capital Retention = Business owner’s potential income
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