Unravelling the confusion between owner compensation and return on investment

You wear at least two hats when you own and operate a business.

One is the employee/manager hat. That is the role where you get paid (or should be paid) a salary for services rendered.

The other is the owner/investor hat. That is the role where you receive (or should receive) dividends or distributions of profit. That is your return on investment (ROI) in the company.

In the book Simple Numbers, Straight Talk, Big Profits  by Greg Crabtree, he says:

“Remember this key distinction: You get paid a salary for what you do, and you get a return on what you own. Why is this so important? Because when you don’t pay yourself a market-based wage, your net income number is lying to you. Or rather, you are lying to yourself.

… If you don’t include a realistic wage for yourself in your financials, your business will always head in the wrong direction.”

Profitability is computed after all payroll

The salary you receive for your role as an employee should be shown as an expense in your P&L just like the other payroll expenses you have.

The profitability of your business should be computed after deducting all the payroll required to run the business – including your salary and related benefits.

Greg says in his book:

“If you’re not able to pay yourself a market-based wage so you can see the true metrics of your business, you’re operating at a loss.

… Keep in mind that a market-based wage is based on what your role is. If you were an executive making $150,000 a year but now you’re a store manager for Fred’s Lawn Care, your market-based wage isn’t $150,000 anymore.”

Owner compensation vs. return on investment

Your goal is to create a business that pays you a market-based salary and delivers a good return on your investment.

Many business owners tend to lump the two together and consider the combined number their “return”. That’s not accurate. And it can make it far too easy to shortchange yourself financially.

This is a really big problem with franchisees. But I see it with independent business owners as well.

Your next step

Take a few minutes to look at these two very important components of the money you should be making in your business.

Then set some targets for what your market-based salary should be and how much of a return you should get from your investment in the business. Monitor those two amounts every month.

It will create clarity and help you develop an action plan to achieve your financial goals.

Maybe more importantly, it will focus you on the difference between compensation for your services and your return on investment.

Philip Campbell’s Blog is dedicated to helping you get the accounting and financial side of your business under control.