How To Pay Yourself -

How To Pay Yourself

"I pay myself $100,000 per year, plus all the cash I can take!" That was the response I got when, as a young shop owner, I asked an older, established owner how much he paid himself. I was curious about how much I should make and how I should pay myself. His answer didn't help me.

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“I pay myself $100,000 per year, plus all the cash I can take!” That was the response I got when, as a young shop owner, I asked an older, established owner how much he paid himself. I was curious about how much I should make and how I should pay myself. His answer didn’t help me.

Compensation for employees is usually pretty simple. We know how to pay technicians and other employees. Flat rate within a market is pretty standard. Hourly rates are also market-driven based on job and required skill level.

istock_66645717_largeBut what about the owner’s paycheck? It may seem that the owner has the best job. But few understand the hours the owner puts into the business and the risk the owner has taken.

There’s a large part of ownership that no one sees — the owner’s sacrifice. In a very young business, they sacrifice a lot! The owner works the longest hours, sometimes with no compensation, so that payroll or other expenses can be met. The owner takes out and personally guarantees business loans. The owner is also on the hook for employee mistakes and can be sued for just about anything at any time.

Owners earn compensation in two ways. First, the owner should earn a paycheck just like any other business employee for working in the business. Second, the owner should earn a return on their investment in the business.

The decision on how much an owner should or could make is best made with the advice of a good, business-focused CPA. Owners should have a complete understanding of the company profit and loss statement. Remember: If the company isn’t profitable, the owner makes no money.

istock_1093557_largeThe Paycheck

As noted above, if the owner is functioning as a manager or technician (or both), the owner should draw a paycheck just like all of the other employees.

Owners of a new or smaller business may simply “draw against the net,” writing a check to themselves and posting the money as an owner’s draw against profits. Obviously, if there is no profit, the draw is taken against the owner’s equity. But there are several problems with this method of compensation. Taxes are not taken into account and benefits aren’t included. Thus, there is a significant risk of “overdrawing” and running out of money before monthly bills are paid.

Additionally, the P&L does not reflect a true picture of the business. Since the owner’s pay comes from net profit, overhead is not accurately presented and the net profit is overstated.

It’s far better to make the owner an employee of the company so that owner compensation is shown on the P&L as an overhead expense. Taxes and benefits are deducted and paid just as with any employee, and the owner still has the option to draw additional funds from profits if warranted.

How much should you pay yourself? If the business is in its infancy, probably nothing. Remember, the company has to make a profit before anyone can be paid. Most business consultants suggest that new owners make sure they have sufficient cash on hand to go six months to one year with no income from the business. But that first year is tough!

Business Plan

In a perfect world, the owner creates a solid business plan prior to opening the doors. That business plan may show the owner working for no compensation for the first six to 12 months. But after that initial period, the owner may plan for a minimal paycheck for the next six to 12 months, then increase his compensation as the business builds.

But the world is not perfect, and most new business owners don’t plan for living on no pay for six to 12 months. The new owner may be working for nothing, but other employees are getting paid. Resentment builds, the new owner decides to pay himself too soon and cash flow issues result. Cash flow difficulty is the No. 1 cause of new business failure. As a business matures, the owner can finally receive a paycheck. That’s a good thing!

Owner pay comes in many forms. Obviously, there is the paycheck. As noted previously, the owner should be paid just like any employee if the owner works in the business on a day-to-day basis. But there are other ways that the owner receives compensation, such as a company car, contribution to retirement plans, flexible hours, expense accounts, insurance benefits, etc. Work with your accountant and tax advisor to make sure those additional benefits are appropriate. It’s really hard to justify a boat, plane or RV as a reasonable business expense for a three-year-old shop making $80,000 per month.

One rule of thumb: if the owner manages the business day to day, the owner’s base pay should be equivalent to the amount the business would have to pay for a general manager. If a mid-sized shop in a market can attract a good manager for $75,000 per year, then $75,000 plus appropriate benefits would be a good base annual compensation for the owner.

Be careful when adding those extra benefits! The business needs to make money. Most use a minimum 10% of gross sales as a goal for net profit before taxes. That 10% net profit allows money to be reinvested in the business, loans to be paid and money to be paid to ownership as dividends if the company is a corporation. But if the total of the owner’s compensation plus benefits such as the car, expenses, bonus, plane, boat and RV drive the net profit below 10%, the owner is being overcompensated and the business is being hurt.

What if the owner is doing work in-shop? If so, the owner should pay themselves an hourly rate or flat rate, just as the other techs are paid. But make sure that the total owner’s compensation does not drive that net below 10% of gross sales.

As the business evolves, many owners hire managers to run the company. As the owner’s active role in the business is reduced, the owner’s pay should shift from being an employee of the company to that of being a stockholder. The manager’s wages should be shown as overhead, and the owner’s pay will come as a dividend payment.

Equity

Over time, the value of the business grows and the money owed against the business is reduced by making lease and loan payments.

While business valuation is a complex issue, there are two basic methods of determining the value of any business: cash flow or net asset value.

Net asset value is usually used to value a poorly performing business or one that’s very heavily invested in inventory. The business is worth its ”net assets,” usually as shown on the balance sheet.

Cash flow valuation uses the net positive cashflow to determine the value. In this method, the net positive cash flow (usually EBIDTA or Earnings Before Interest, Depreciation, Taxes and Amortization) is multiplied by a number to arrive at the business value. The number, or multiplier, is a negotiated number representing the number of years the buyer is allowing the net positive cashflow to repay the investment made in buying the business.

Example: A shop has a net positive cash flow of $150,000 per year. It has a strong business, is well managed without the owner’s full-time involvement, has a solid crew and has shown several years of positive sales growth. Using that information, the owner negotiates a multiplier of 3.5. The business has a value of $525,000 ($150,000 x 3.5). Remember, that does not include the real estate. In selling the business, the owner should negotiate a fair market rent for the property.

Rental income is an area that’s frequently overlooked as owner compensation. Often, the business owns the real estate housing the company. As time passes, the loan balance diminishes while the fair market lease rate increases. The building and business should be separate entities, with the business paying a fair market rent to the owner of the real estate, usually the owner of the business. The difference between the fair market rent and the payment can be income to the owner. In our example, the owner will receive $525,000 for the business, plus rental income from the property.

Business owners should keep an eye on equity as they build their business. To maximize equity, the business must be profitable, should show steady sales growth and be systems driven so that the company is not dependent on the owner for daily operations.

There is no simple answer to the question, “How much should I make as the owner of an automotive repair shop?” But by truly understanding the financial structure of a business, and working with a business-focused CPA or accountant, a good compensation structure can be created for the owner.

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Shop Equipment ROI – Tooled for Profit

Understanding how to calculate ROI can help your purchasing decisions.

I’m not a financial scholar by any means, but I know what return on investment (ROI) is. It’s a mathematical formula that yields a representation of the profitability of any type of investment. In the automotive repair industry, we primarily associate this with equipment. Admittedly, I’ve never used the term much, more often approaching things from the standpoint, “Am I making money with this or not?” As technicians and shops, our typical thought process centers on each individual job, how much time and money we have into it, so we’re used to thinking profit or loss, and also pretty good at knowing if we made money, or if we lost our “back quarters.”But over time I’ve learned that the thought process alone is not always the best approach, and making money doesn’t necessarily mean a good ROI. Even if you don’t go crazy with an exponentially long, complicated equation, if you understand the basic idea and process of calculating ROI, it can help you make good purchasing decisions. The base calculation would be dividing your net profits by the cost of the equipment. That’s your ROI. Then, if you want to take it further, you can divide that number to get a time-based ROI average.Let’s look at a basic calculation. You buy something for $10, then sell it for $14. Your profit is $4. Divide profit by investment, ($4/$10) and you get an ROI of 40%. Not bad, but if it took two years to make this profit, then your ROI would be 20% annualized, which is not as impressive. You can use this basic formula to compare products you sell as well, and it may help you decide what’s best to keep in stock or not.Now let’s try something with equipment. You have an old tire machine that’s paid for. You average one set of tires per week and it takes 1.5 hours to complete the job. You decide to buy a new tire machine that is much quicker and more efficient but it cost you $20,000. Now the same job only takes one hour. Based on the cost of technician salary, you calculate that it saves you $30 per job with this new equipment. In this case you would use the formula: savings (additional profit)/investment. At one set of tires per week, that works out to $1,560 per year. $1,560/$20,000 equals an ROI of approximately 8%. That’s not too good. It will take you almost 12 years to pay off the new machine.On the other hand, if you average five sets of tires per week, then your additional profit for the first year is $7,800. $7,800/$20,000 equals an ROI of 39%. That’s pretty good. A general rule of thumb is to pay off any piece of equipment within two to three years. This puts you right on track.But now, here is the problem. This is where we throw the proverbial wrench into the plans. Equipment is tricky. You should also calculate in installation and maintenance costs, as well as the cost of training for the new equipment, and factor in how long the equipment is going to be relevant. This is an especially important factor when considering a scan tool, the required updates and how long before it’s potentially obsolete. In the case of a tire machine, you can also calculate in savings from other benefits of a new machine, such as no more damage to wheels or tire pressure monitoring system (TPMS) sensors, which the new machine can eliminate.Some of this can be overwhelming, and it makes me realize why it’s easier just to fly by the seat of your pants and wonder, “Am I making money or not?” It’s an important business aspect, however, to know what is behind the idea because it can benefit you in so many ways. Even without math, you can almost visualize the numbers in your head.I’ll try it by leaving the formulas out to decide whether it makes sense to buy a dedicated TPMS tool when you already have a full-function scan tool with TPMS ability.If you get a TPMS problem every day and you use your full-function scan tool to diagnose it, most likely it takes much longer to boot and longer to navigate to the function. Even then, it may not cover all you need. Because there’s such a vast amount of information that a full-function scan tool has, it simply takes more for the manufacturer to keep everything current. Plus, you often must still rely on service information for certain procedures and then, if it’s the only scan tool for your shop, it ties it up for use in other diagnostics.Now, let’s compare that to a dedicated TPMS tool. Built with only one function in mind, they can make the process much quicker, have greater coverage, boot quicker and quickly walk you through all steps of any required TPMS resets. When you factor in the savings in time and the fact that your primary scan tool isn’t tied up, you can prove the value of a dedicated TPMS tool through ROI calculations. On the other hand, if you rarely work on TPMS systems, you can prove it wouldn’t make sense at all, since you do have the function on your primary scan tool.While you haven’t done any calculations, you’ve thought of it in that manner and can picture where the calculations might end up. If you’re on the fence, the math will give you the answer. Ultimately, your accountant could take the idea even further, with an undoubtedly more advanced knowledge of ROI, and almost certainly a way to calculate depreciation into the formula. That’s where I sign off, but you get the idea. It’s a great concept that represents fundamental business financials.

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