Whether you’re just starting out, or have found it necessary to retrench your kitchen and bath firm to a smaller, leaner operation, you may find yourself in a situation where you are operating as a virtual sole proprietorship.
If your business is a sole proprietorship, partnership or Sub-S corporation, it’s easy to mix your personal affairs with those of the business. Whatever the situation, there are some legitimate ways to minimize the impact of taxes on you and your business, and there is no reason not to take advantage of these.
There are, however, a number of potential pitfalls to a situation such as this. As long as you do not have any employees (or you have very few employees), the main difficulty is in maintaining accounting records that allow you to properly identify personal and business expenses.
The bigger issue will arise when you begin to grow and add employees. It’s at this point that the danger arises that these employees will perceive that you are using the business as your personal “piggy bank,” limiting their and the business’ opportunity to grow and prosper.
Most people will understand that, because the business owner is taking most of the risks, he or she is entitled to a larger share of the rewards. While that’s the case, it’s important that everyone buys into what’s going on. The key to this is to be open and up front with what you are doing with your own compensation, perks and benefits. It’s even more important that these not be out of line with what the business can afford to pay out and still be sound and competitive.
A bigger issue that should be addressed right from the start is that of maintaining the discipline that will allow you to separate short-term cash flow from long-term profitability. It is not uncommon for small businesses, operating as sole proprietor or partners, to adopt accounting methods that provide for owner drawing accounts, where the owners take out money as needed for their personal affairs. Because of the nature of the construction business, particularly remodeling, payments are often collected from customers before the related expenses are billed to the business.
Give serious consideration to establishing yourself and any partners as employees of the business with a fixed salary right from the start, and treat your compensation as you would that of any other employee. Early on, you likely will set owner salaries relatively low and award a bonus periodically as profitability allows. We will discuss below the benefits of overall bonus programs for a business.
As your business grows, you will find that there is more and more distinction between you, as the owner, and your employees. At this point, it’s time to evaluate how you are organized and how you operate in order to more clearly separate your personal and business affairs. There are certain things that will stand out as problem areas and we can take a look at them.
As the number of employees grows, it’s important to establish a rational compensation policy for all of your employees, including yourself. As a small business, it is not unusual to have negotiated individually with each employee for their compensation. Address this situation as soon as you can if it has resulted in inequitable compensation for these employees. As mentioned above, your own compensation should be based in accordance with the business’ ability to pay you.
Inequities in compensation of employees within a company can be one of the most serious morale problems that any business can face. While most small businesses treat compensation as a highly confidential area, the reality is that it’s likely that most of your employees knows what the others are making. The best test of fair compensation is: Could you post your pay rates on the company bulletin board and not receive any complaints?