Is it salary or profit?

It’s always a little weird to pay yourself when it’s your own company. We get it, this is our company (hi, Preston here) and it seems odd to have a set monthly amount to pay yourself.

It’s easier to just think, well, I will pay myself what’s left. Reasonably. If there is anything left.

After a while, you get a little more comfortable and then start paying yourself a salary.

Then things start going really well. Patients are coming through the door. Things are pretty efficient. You finally got that credentialing headache sorted out. So, this month when cash is good you take some more.

Call it an owners draw, but just run through payroll. Or at least put in the salary bucket in Quickbooks.

While this is common and totally innocent there can be issues. No shade, just things to think about.

1. Operational metrics

If you take an extra $100K one year, $125K the next, and then $88K the next, which year did you do the best?

Well all things being equal, based on the P&L and cash flows, you did the best in the most recent year because operating expenses were lower based on less of the owner’s draw running through expenses.

When you pull profit out of the business but let it hit the P&L you can artificially suppress performance metrics.

2. Investment

Amazon lost money all those years because it invested every available dollar back into the company. You can see publicly traded companies take cash generated from income and put it to work through hiring, acquiring, innovating, and purchasing.

The excess profit made from the business is allocated based on what’s best for the organization. Sometimes that’s a distribution. Other times it’s throwing it on the mattress in an old bank vault. And other times it’s best to invest it.

Whatever the determination, taking draws without significant rigor as a pseudo-salary, impedes a businesses ability to allocate capital effectively.

3. Expenses

Last month was great! But guess what, you have an expense and a clawback coming next month that you don’t see coming.

But because cash ran high, the excess cash was used for a few bonuses, a few extra cases of eggnog for the holiday party, and distributions.

Unfortunately, that puts the practice in a tight spot when the bills come in and the cash payments are reduced.

4. Valuation and exit potential

When you go to sell your practice, one day, if you are into that sort of thing, the first thing you are going to do is normalize earnings. Well, before that you might call an awesome investment banker (let me know I will introduce you to one), but he would probably work with you on normalizing things.

You may see it if you look prospectuses or have heard the term SDE (Seller’s Discretionary Earnings). That’s basically taking the extra payments, the beemer lease, all those extras out of the operating expenses of the business to normalize earnings based on real operations.

What you may also run into is a scenario where what you thought was going to be a sky high offer falls short. That may be due to the fact that instead of years of investment and cash retained by the business, it was paid out in distributions.

Not only is that a reduction in real value, but investors may see that as having already realized returns on the business, ones they do not see fit to duplicate in the exit.

In fancy terms you can think of this all as fair market value for services vs. return on equity. Essentially salary vs. distributions.

There are impacts to business operations, profit visibility, expense management, and eventual exit value.

Wrapping up

Whether you use fancy terms like fair market value or just say salary like a normal person, there are real implications for how you take money out of your business. As an owner you are entitled to the profit, but you also have another job: to be an effective allocator of capital.

However you approach that implied job title, will impact how your practice grows and potentially exits.

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