4 Simple Steps to Cover Overhead Costs and Pay Yourself What You Deserve
You’re the CEO, did you get paid for 2016?
“Pay yourself first” is likely a common phrase heard among your business peers, but it’s easier said than done. There’s always a reason to put yourself last for the sake of the company’s investments and bottom line. But this habit, though well intended, can actually be hurting your business and derail your company’s long term goals. As an owner or CEO, your main objective is to grow your business and make a good living while ensuring the business covers its overhead. So how do you plan appropriately to cover your operating costs without sacrificing what you plan to pay yourself? The answer might be easier than you think.
There are two things that can be done to increase the likelihood that you’ll take home what you want at the end of the year:
- Increase revenue
- Reduce costs
For most companies, it is easier to cut costs than it is to increase revenue. Thus, the best place to begin is by gathering some financial data.
- Gather Financial Data
What you’ll want to do first is take a minute to evaluate your business and your latest financials. What are your five key expense buckets? Every business owner should know how much they spend in each of these key buckets and how these costs change over time. Typical categories include things like cost of goods, staffing, owner compensation or other large overhead costs. If your company has a significant amount of debt service, create a bucket for this too. Understanding the makeup of your key cost areas is critical to knowing whether you’re spending money in the “right” place. Once you have identified your key buckets, gather financial information on how much was spent on each in the past 2-3 years. Next, look at these items as ratios (as a percentage of revenue). This will help you gain a clear picture of how much revenue your company spends in each of these key buckets and it will help you compare (normalize) the figures over the 3-year period.
- Compare Your Results to Industry Standards
Next what you’ll want to do is compare your results to your competitors or industry standards. If you don’t have access to industry information, this website may be a useful place to start. You may need to take into consideration key differences in your business model to those of your competitors or industry standards. For example, are you the low-cost provider of your product/service or do you offer higher value-add than standard industry practices? Alternatively, is your product/service mix different from the comps? Even if these metrics aren’t perfect, it’s a helpful place to start. If you’re not able to gather information on what other companies are doing, you could also use your own data for years when margins were better and consider what has changed.
- Work Backward from Your Bottom Line
Then, it all comes down to your bottom line. To pay yourself appropriately, what do you need to do to close the gap from where you are now? Once your data clarifies where your margins are and you identify where you want them to be, it becomes easier to see where overspending happens and help you devise a plan to achieve your compensation goals. To work backwards, start at your bottom line – if your company earned a 5% net profit margin and paid you 3% of gross revenue, but you want to earn 15% net margin and pay out 8% for executive compensation, consider which of your key buckets are the easiest to change. The following can be used as an example:
In the example above, this company identified that it was easiest for them to 1) go back and renegotiate some of its supplier contracts to get a discount and reduce its cost of goods, 2) cut back on spending for meals and entertainment, and 3) sublease some of its office space that was no longer in use. By achieving this, the company was able to increase its executive compensation and bottom line to where they should be.
If evaluating these buckets as a ratio makes it difficult for you to see the full picture, convert these figures back to dollar amounts spent. If you spend the time to fully appreciate how much these items actually cost you, it may help you figure out the easiest places to cut back.
- Establish Benchmarks and Stick to the Plan
Once you have identified the areas to trim, you can then use the resulting ratios as benchmarks or goals for each key bucket and create a plan for achieving these goals. To realize your objective, you will want to look at these figures monthly and consider them as guidelines and guardrails. Then you’ll want to know, were you off the mark last month? Why? And what can you do to correct it for next month?
Keeping these benchmarks consistent and establishing a process to evaluate them regularly will help you manage your cost items throughout the year so that non-standard expenses (like moving office space or adding a new network) does not cut into your share of the pie. Taking the time to consider how these expenses change your performance against your baseline will help you plan ahead to cover these costs as they arise. If you do not, deciding not to pay yourself to cover these additional expenses is a slippery slope. You risk burnout or not having enough reserve capital (either personally or in the business) to fund your company in the event of a downturn. Establishing good habits now will make sure you not only pay yourself what you deserve, but you also ensure the longevity of your firm.
In general, a CEO’s compensation (including insurance, draws etc.) should be around 7-8% of the company’s gross revenue. If you ever need to sacrifice your compensation, it should be considered in advance and must involve a solid plan. For example, “I will not pay myself for three months in order to create X amount. With X amount, I am going to hire three additional sales members to achieve Y and then reinstate my pay in 90 days.” The decision then becomes proactive rather than reactive.
Consistent analysis of your business can be overwhelming at times, especially when you’re already stretched as a business owner or CEO. But doing so can be a game changer for you and your company’s income and growth. If you have any questions about how to create a template for evaluating your key cost buckets or if you need assistance gathering relevant information, we would love to help. Gemsbok’s professionals have over 15 years of experience developing and reporting on key financial metrics and have helped hundreds of firms grow and improve their business. Give us a call at 303.249.4687 or email Christina at firstname.lastname@example.org to set up a time to discuss your business and its goals.
Christina Griggs is a financial expert and spreadsheet maven that has spent her entire life in and around the business world. Christina has worked as a short-interest trader in London, as an investment advisor with Dean Witter (now JP Morgan), as CFO for a corporate housing firm and CFO for an eCommerce marketing agency. This experience, along with her client work at Gemsbok allows her to continue to cultivate her enthusiasm for financial analysis. Visit our website or contact us for more information on our firm and services.