Most of us go into business because we want to make a decent living doing something we enjoy. We want to be able to provide for our families and enjoy the fruits from our efforts.
One of the biggest mistakes business owners – particularly new business owners – make is confusing profit with revenue. Don’t assume just because the money is in your bank account, it’s available for you to use. As a business, you need to put your liabilities – debts, paying suppliers, payroll, tax obligations, etc – first.
Remember that the money you take out of the business can’t be used for growth, and growing the business is what will allow you to continue to increase your personal earnings over the coming years. So think carefully about what you’re taking out of the business and if it’s really necessary.
Here are our tips for thinking about how much money to take out of the business:
Pay yourself regularly
There are a number of ways of paying yourself: drawings, salary or dividend. Paying yourself a fair and reasonable amount each month is a much more sensible option than taking out huge chunks of money at once. Regular payments help you to budget your household expenses, the same as if you earned a salary. And – perhaps more importantly – large chunks of money can look suspicious to the IRD, who may decide to investigate your company or to a liquidator if everything goes horribly wrong. Your accountant can advise you on the right amount to take out monthly and how to do this in a tax-efficient way and in compliance with your director obligations.
If you cannot pay yourself, you should be asking whether your company is a serious business, or just a hobby.
Are you fulfilling your directors duties?
Of course, the other factors to consider when you’re taking money from the business is if you’re leaving enough money behind to fulfill your legal obligations. According to sections 131-136 of the Companies Act, you need to meet certain obligations under Director’s Duties for your company.
How much you can pay yourself may be restricted by the structure of your business or the business constitution. The company will need to pass a solvency test before and after making distributions to shareholders.
As a company director, you are accountable to your shareholders, and you must not carry on the business in a manner likely to create a substantial risk of serious loss to the company creditors. You need to act in good faith and in the best interests of your creditors. Chapman Tripp published an article in May 2016 that explains when directors may or may not be liable.
Your business must also pass the “Solvency Test”, meaning that at any time you own more assets than liabilities and you are able to pay all your debts as they fall due. Exactly what this means varies depending on your business, and you can find more information in our article about Director’s Duties or on the NZ Business page.
When NOT to pay yourself
There are certain situations where you, as the business owner, shouldn’t draw money from the company for personal expenses. If your business is in financial trouble – for example, you don’t have enough liquid cash to pay your upcoming debts – you need to do whatever you can to ensure you’re meeting your trading obligations and remaining solvent. You should know not to pay yourself until the business can get back on its feet.
Remember, if your business is forced to liquidate, you may have some personal liability. Your accountant should be able to advise you when your business is in financial trouble and when you’re no longer meeting your Directors Duties under the Act.
If you’re concerned about the state of your business and worried about the funds you’re taking out, this is where a business recovery specialist can help. Contact us now.