Guidelines for Distributing Cash

How do you perfectly distribute cash? We surveyed gym owners in this Profit First for Microgyms group, and this was one of the frustrations that came up in a variety of different ways in which people said it. But ultimately, the frustration is not knowing how to perfectly distribute cash. So first, that's the question, or Scenario frustration that I want to talk about today. First thing to know: perfect is such a dangerous word. You can still have a very profitable, wealthy life, happy, enjoyable, without doing things perfectly. So first know that especially when it comes to money. Don't be shooting for some sort of really fake idea of there's a perfect way to do it. Um, one of the things that we tell people about the Profit First system in general is that it's a set of guidelines. And the reason we say that is because every owner can take the guidelines and make it work in the way that they do business. So when we're now talking about how do we distribute cash, my assumption, and this is the way I'm answering the question, is based on this idea that we're talking about distributions to ourselves. How do we pay ourselves? How do we make sure the way we do it is the right way? Because perfect, not a great word. There is a right way. I think. Now that doesn't mean the right way includes a specific, uh, like has to be $17.22. Uh, it's not like some sort of perfect right number that way, but there's a right way. Um, okay, so we have the Profit First system, which we have our different buckets, our smaller plates, and in those buckets, the ones that we're going to focus on that distribute money to ourselves. We have the owner's pay bucket, we have profit, and then we, um, also have the tax bucket. Now, if you're coaching classes and you're using the team member bucket, I'm not including that. Just the general rule of that is if you're coaching a class, you're going to pay yourself out of the team member bucket the same way you would pay any other coach. That's taken care of. Like, if you are paying $25 a class, And you teach a class, you pay yourself $25 out of the team member bucket. Well, let's talk about the intricacies between the owner's pay, profit, and then tax account from the Profit First side. Owner's pay is compensation for working in the day-to-day. We want to make sure that the owner's pay amount is at least as much as your minimum viable living expenses. And the way I think about that is roof over my head, food on the table, transportation to get to work. Um, I know it sounds really rice and beansy, like a Dave Ramsey idea, but it's important to know what that dollar amount is because you cannot pay yourself less than that dollar amount if you're working in the business. And if you can't afford to pay yourself that much, you need to hire a coach to help you figure out how to get more revenue in. Um, you've got to have those 3, at least those 3 expenses. Then from there, usually with the Profit First system, we do a cash flow analysis, which you can do. Uh, the book talks about it. You can go to profitfirstformicrogyms.com. We have some free resources. But ultimately you do an analysis and that gives you the percentage of your revenue that you're putting into the owner's pay account. In most cases, that dollar amount we have found is more than the minimum viable amount. Those 3 expenses, we're more than covering those. That's great. So that's owner's pay working in the day-to-day of the business. So if you have business partners, don't work in the day-to-day, they don't get paid out of owner's pay. Profit account is for those owners and you. Um, the profit account is for all owners, and the purpose of this account is to reward you for the risk you're taking for being the owner of the company. Uh, your coaches are not taking that risk. Your vendors do not take that risk. If your company goes under, the coaches go find another job. And while that's a headache, it's not quite the same detriment as it is for you if you have to close your business. And same with the vendors— you go out of business, they find another customer. It's no big deal. So profit, though, is paid to all owners. And again, you do the cash flow analysis, you come up with what the percentage of revenue is, and now the right way to use the profit account Is that once a quarter you're going to distribute half of the dollar amount that's in your profit account. The other half stays there for kind of a rainy day fund. And I can tell you, after COVID happened, our gyms who were using this methodology before COVID happened were very grateful to have that balance sitting there. If you ever get to the point where that balance becomes really, really large, you know, give us a call and we can talk through the advanced strategy of what to do in that case. Okay, so owner's pay, it's a dollar amount paid to you for working in the day-to-day of the business. Profit account is given to all owners as a reward for owning the business. The tax account is Going to accrue dollars throughout the year so that come tax time when you owe taxes, you have the money already set aside. The business set it aside for you. That means you can live off of the owner's pay amount, the complete dollar amount. When it comes to taxes, theoretically, the IRS wants business owners who don't pay themselves a W-2, and really they want business owners to do this regardless. To make quarterly estimated payments. Those quarterly estimated payments are based off of your last year's tax bill. And the IRS does it because if you don't pay in a certain dollar amount, they hit you with what they call an underpayment penalty, which again is effectively calculated based on how much you owed in taxes last year compared to what you owe this year. Compared to how much you paid in this year before your taxes were actually due. Now, that's the letter of the law per IRS. Pay a quarterly tax distribution. And even in Profit First, the original book, Mike Michalowicz talks about making a quarterly payment, basically saying whatever's in your tax account, send a check off to the IRS. I differ. Based on my experience as a CPA, and I personally don't do that. So here's how— the way I look at it. To avoid the underpayment penalty, as long as you've paid in the correct amount by January 15th the following year, or basically the year the tax return is actually due, you can avoid the underpayment penalty. I also know that, man, stuff happens, like say COVID. And when push comes to shove, I would prefer to have the money available to myself to make sure I can stay in business than to have to wait until I can file my tax return to get a refund because I ended up overpaying. Because usually when stuff hits the fan, that results in a lower amount of tax owed. So how do you distribute the tax money? Here's my recommendation: keep accruing it in your tax account. Then in November, December, this time of year, actually do a tax estimate and see what you are going to potentially owe in taxes, because you have now 10 to 11 months of actual data. It's going to end up on your tax return, and all you have to do is guess what the next month is going to be. Where if you're doing estimated payments, you're just basing it off what you previously owed. Um, and again, that could have been way too high, or sometimes it's even way too low. I mean, people get to tax time and they're like, I made all my quarterly estimates, I don't understand why I even owe more money. Because it's not based on anything other than last year's taxes. And sometimes, especially if you're using great business mentors to grow your gym, you might be experiencing some tremendous growth. And your estimated payments aren't going to take— they're not taking that into consideration. So I prefer to have control over that money for as long as possible. So I'll do an estimate, I make a payment in December. I theoretically could wait till January 15th. I personally just choose to do it in December. And it's a full amount, but the money's there in my tax account. So that way, come tax time, if December really got away from me, I might owe a little bit or I might get a small refund, but usually I'm pretty spot on. That's how I would distribute the tax amount. Now, that being said, the amount you are paying if you're doing that method means that you're likely going to have money left in your tax account because usually the percentages that we come up with have people slightly oversaving, not drastically, but slightly. If that's the case, you are more than welcome to distribute the difference to all the owners as a profit distribution. Some people like to hold on to it until the actual tax bill is due so that they know that in case they ended up owing a little bit more than what they actually paid in, they have the money already available and then they distribute to themselves. But I do recommend doing it that way. At like as the latest, meaning I think you should always, if you've oversaved on taxes, give it to yourself as a profit distribution. Now, whether you want to do that when you make an estimated payment in December or when you actually pay the tax bill and know what the final dollar amount is, that's up to you. But distribute the excess amount to yourself. Now, keep in mind, if I filed in April, I know I'm getting geeky here, but I'm trying to answer the question, how do you know how to distribute cash? So we've taken perfectly off the table, but here's how you have to look at it. I've saved money from January to December of 2021 for my 2021 tax bill. I make a payment in December and I choose to hold on to the excess amount. That means January through April, I am now saving money in my tax account For my 2022 tax bill. So when I actually file, let's say I file in April on the deadline and I don't owe any more money. So whatever my balance was as of December 31st, because I've already made my payment before then, that's the dollar amount I distribute to myself. I'm not taking my tax account down to zero because I have January through April of savings in there. Or my 2022 tax bill, right? So don't distribute the dollar amount down to zero. Distribute the excess that you saved during the year. Hopefully that makes sense. So if you follow that system, you don't have to perfectly know how to distribute cash to yourself because the system tells you basically how to distribute and when to distribute. Owner's pay is paid to you on your normal payroll stuff. We do monthly payroll at our company, so once a month I get my owner's pay account amount. Profit distributions are once a quarter. Tax accounts, for me, I prefer and recommend doing it once a year, but I get that not everyone wants to do that way. If you want to make estimated payments, go for it. You're not going to get in trouble. Again, these are guidelines. Fix or pick what works for you. Going back to the owner's pay amount on the Profit First system side, Usually my percentage of owner's pay is actually more than what I've committed to bring home into my household, me and my wife. She knows how much I plan on bringing home. And so we take home that amount. So there is some excess, especially with the ebbs and flows of a tax season where we are getting a big chunk of money, an increase in cash between January and April, and then a few months later in the year. And then we have some really dead months. When it comes to cash flow. So anyways, I use my owner's pay account as a buffer so that I can always make sure I can bring home the amount that me and my wife live off of. And then same concept, the December 31st balance, whatever's left, I can take that at that time as kind of a lump sum distribution. So again, we've talked about the profit-first side. I now want to talk about the tax hat, because I think this is where sometimes the confusion happens. I feel like most of the time when I explain what I just did, most business owners are like, oh, okay, I got it. But then they start thinking about, well, is that a distribution? Is that an owner's draw? Do I pay myself all that in a W-2? Do I need to create another business and have income flow through that? Should my spouse have a company? Should I— All my children have business entities. Should I create a life estate trust plan? It's like, whoa, okay, let's figure that out. So from the tax side, most gym owners and business owners should have an S corporation somewhere in their structure. Now, again, always consult with a CPA to make sure you have the right structure. But in most of our cases, we see S corps being a good decision. S corps require you as the owner to pay yourself a W-2 when you're working in the business. Now, that W-2 amount only has to be reasonable. So let's say my owner's pay percentage on the profit-first side pays me $100,000 a year. And from a W-2 standpoint, for tax purposes, I only need my— only need to pay myself $30,000. in a W-2 to be compliant with the tax code. So what do I do with the other $70,000? Don't pay yourself that on a W-2. If $30,000, uh, $30,000 on the tax side is the appropriate amount for W-2, that's the max you should pay yourself on a W-2. And you run that through payroll just like you're running your other payments to your other employees. W-2 employees through payroll. The other $70,000 is taken as a distribution. Now, distribution, shareholders draw, owners draw, all of those phrases mean the same thing. You're basically taking money from your business account and you're transferring it to your personal account. And in your books, you're booking it as an equity— as an equity account called owner's distribution, Or shareholder draw or owner's draw. They all mean the same thing. Pick whatever word you want to say, but it is an equity account on your balance sheet. You got to make sure it's getting booked that way. So again, in my example of $100,000 of owner's pay percentage, but $30,000 W-2, so I'd have the $30,000 W-2, this other $70,000 I take as a distribution. Profit. If I'm taking money out of my profit account, those are going to be distributions. And then the tax stuff as well. People always ask, should I pay the tax bill directly from the business account or from the personal account? Look, ultimately it really doesn't matter from a clean standpoint. And if you were audited, it would just go more smoothly and less explanation needed if you Transfer the money to your personal account and pay from your personal account. So normally that's the advice we give, but don't beat yourself up and think you're going to go to jail if you ended up paying for your tax, your personal tax bill directly from the business. You would just book that as an owner distribution on the business side. So again, that, that's going to be a distribution. Now the last thing that I'll say, and this is for those of you who are familiar with the corporate rent Augusta Rule tax strategy that we talk about all the time. This is where you rent your house to your business. I won't go into the details here, but assuming that's a $1,250 payment, which is an expense on the business, that's still an owner's pay percentage. So theoretically, my owner's pay from a tax perspective is paid to me, one, through a rent expense, Which is still a transfer from the business account to my personal account. We're just booking it as a rent expense on the books. A W-2 amount, which is going to get run through payroll, and then the payroll company deposits money into my personal account, and then a distribution. Those 3 ways. Anyways, that's a lot of nitty-gritty technical stuff, but I don't want you guys to be frustrated on like, what's the perfect way to distribute cash? There's no perfect way. I've explained to you the right way, and now you can go and choose how your business— how the way you run your business, how the way you run your personal life— can fit into those guidelines that I just provided. Um, and don't lose any sleep over this. Uh, anyways, uh, hopefully that helps. Profit is a choice. Have the courage and wisdom to choose it.