Is Your Profit Number Telling the Truth? Check Owner Pay

Two contractors, one business

Picture two contractors, each with $1.2 million in sales and identical costs. The first runs his company as an S corporation and pays himself a $110,000 salary, which shows on the statement as an expense. His profit line says $72,000, or 6 percent.

The second runs an LLC and takes draws instead of a salary. Draws do not show as an expense, so his profit line says $182,000, or about 15 percent.

Same business, same work, same money in the owner's pocket. One looks like an average contractor; the other looks like one of the best in the industry. Neither statement is wrong. They just are not measuring the same thing.

Know which way your industry measures it

Industry benchmarks pick one way and stick to it. For construction, trades, restaurants, retail and most other businesses, the published studies measure profit after the owner is paid a fair wage for the work they do. So if you take only draws, your profit line includes your own pay, and it will look better than it really is.

Professional practices usually go the other way. Surveys of law, accounting and dental practices report profit before the owners are paid, because in those firms the owners' take is the profit. The AICPA's survey of CPA firms, for example, reports "net remaining per owner." So a law firm that pays its owner a $200,000 salary through payroll will look about twenty points worse on $1 million in fees than it really is, if it is compared without adjusting.

How to read your number fairly

Two questions put your statement on the same footing as your industry:

• How much of your expenses is owner pay? Officer salary, owner wages, or guaranteed payments to partners.
• What would it cost to hire someone to do your job? If you run the jobs, sell the work or manage the office, that role has a market price, whether or not your statement shows it.

With those two answers, your profit can be compared to the right benchmark. Without them, the comparison can be off by more than the whole gap you are trying to measure.