How To Limit Your Personal Drawings From Your Business
Personal overconsumption is an ill that I’ve long found afflicts too many Kiwi smallbusinessowners. By overconsumption, I mean that your Personal Drawings from your business exceed what’s due to you. And what’s due to you from your business at any one point in time is represented by profits allocated to you, plus funds you’ve injected, less your previous Personal Drawings.
If you operate through a company and you owe it money because of excessive Personal Drawings, then other implications arise. For example, taxation (you’re charged interest on this loan to avoid FBT), and on insolvency (you’re personally responsible for the repayment of your debt to your company – and for company debts if your company trades whilst insolvent). Be mindful that these comments are all of a general nature only of what is quite a complicated area – so they shouldn’t be relied upon without our detailed assessment of your particular situation.
Some suggestions on how you can limit your Personal Drawings:
· As a first step, carefully forecast your business cashflows. Be conservative. When forecasting your working capital needs, allow for seasonal activity changes, one off capital expenditure, tax payments etc. Do this for the next 12 months. Then monitor it.
· From your forecast, calculate how much you can afford to pay yourself over the next 12 months. Limit this to no more than 2/3 of your business’s total forecast cashflow surplus over the next 12 months on a rolling basis. That way you’ll retain enough to cover your personal tax commitments, plus any unexpected working capital needs for your business.
· Once you’ve forecast how much your business can afford to pay you, prepare a personal budget showing how you can live within this amount. Don’t make the mistake of starting off this whole process by forecasting the amount that you need from your personal budget calculations - your business forecast directly influences your personal forecast, not vice versa.
· If you’re not forecasting a profit from your business – especially if you’re in a startup phase – then I suggest that Personal Drawings can’t realistically be justified. This is a time for a great deal of personal sacrifice and discipline whilst you cut back on your personal expenditure in order to live from non business income, or family member support, or even from capital.
· Divide your total forecast Personal Drawings for the next 12 months into equal (usually weekly or fortnightly) payments. Then pay yourself, period by period, just as if you are another employee of your business.
· Be disciplined - stick to this amount. Avoid the temptation to treat your business bank account as a piggy bank that you can raid at will whenever you overspend personally.
· Pay yourself first. Fix your Personal Drawings limit in advance through the good times and the bad so that, provided you really are committed to your business, you put yourself in a position to invest as much of your income as you possibly can. The more you do this, the greater the potential in the future for your business to create choices you wouldn’t otherwise have. The potential to throw off surplus cash for you to invest either in your business, or elsewhere…or even to consume personally. Wouldn’t you want to become a more fastidious investor in your business – the asset that potentially offers you the fastest growth and highest cash returns?