Incomes play a vital role in an individual’s life, which is why people tend to look for ways to generate multiple profits or even choosing between the type of monetary benefits they receive instead of their services. Both salary and dividends are incomes, the varying factor is one you buy beforehand and earn a profit on, and the other is paid to you for your services to the company. Let’s explore both of these in detail.
The salary is the remuneration received by a person as payment for their work. In this way, the employee can benefit from his contribution in time and effort to the company that hires him and see that contribution translated in monetary terms.
Salary is the price paid in exchange for work performed by a person, according to supply and demand of work. It is based on various factors such as the availability of labour, trade union agreements, training or experience of the worker and the country’s labour legislation.
Since the salary is the income that each person receives and thrives on many governments establish social measures to ensure that a minimum amount to live is offered, known as the minimum wage. The minimum wage is the smallest consideration a worker can receive for their work within a particular day. In the same way, we can talk about maximum salaries, which function as legal ceilings to which employees’ compensation must be adjusted. The legal system of each country determines both the minimum and maximum wages and are part of their respective labour laws.
Salaries through taxes are one of the primary causes of financing for States. It requires the delivery of a proportion of the salary to the Government. Depending on the country they are paid in, these taxes are divided into two, the Social Security payment fee and the personal income tax (personal income tax). In this way, the gross salary is the total amount of the consideration received, while the net wage is the remaining amount after deducting the mandatory contributions, as well as possible tax withholdings.
The dividend is the part of the profit of a company that it decides to distribute among its shareholders. It is, therefore, an income that the shareholder receives for owning the company.
Usually, companies close their annual accounts in December, which means that it is then that they calculate the profit or loss they have achieved with their business over a whole year.
If it has obtained a benefit, the company must decide what part of those profits it will distribute among its shareholders, which will be voted on by shareholders in a meeting that they hold at least once a year called the General Shareholders’ Meeting.
Ordinary and extraordinary dividends
It is not necessary to deliver the dividend in a single payment. Thus, in the last months of the year, companies have approximate ideas of the result of there activity. So it can decide to anticipate a part of the dividend. For example, from September, companies’ can choose to pay a dividend on an account of the result of that same year. Once the annual reports are closed, and with the certainty of the benefit obtained, the company can pay a complementary dividend.
This type of dividends is ordinary dividends since they are obtained by sharing the profit that the company has achieved in what is its main activity.
However, sometimes, companies can also earn money with unusual activities. For example, a company whose business consists of selling clothes through a network of stores can obtain an extraordinary benefit from the sale of one of its stores. If you decide to distribute that benefit among your shareholders, you will do so through the payment of an extraordinary dividend, which indicates that it is an exceptional payment and is not expected to continue in the coming years.
In recent years, it has also been customary among Spanish companies to offer the flexible dividend, instead of paying the shareholder a cash dividend directly, they are offered the possibility of receiving more shares from the company itself.
It is also necessary to point out that dividends must be announced by the company well in advance of its payment. It is not only for the correct valuation of the shares in the market but also for the accurate assessment of other products such as futures and financial options.
Salary vs Dividends
There are reasons for internal management, coexistence with partners, and even taxation that determines if one should choose salary or dividend as compensation.
What do I do with my compensation? Do I collect a salary or dividend withdrawal? It is one of the difficult questions that any entrepreneur poses when his venture is already running on rails. A company does not always reach that instance, of course. And in the meantime, the answer is usually more straightforward: money is withdrawn as the box allows.
But even when the owner is only one person, the company can benefit if it formally establishes how its compensation will be. If the partners are two or more, the issue becomes indispensable.
Many small entrepreneurs are tempted not to pay a fee, especially when it comes to signatures of a single owner, or when the company has little time to live. But the entrepreneur must understand that he must establish his remuneration not only to value the time and capital invested but also not to skew or alter the company’s results.
Salary and dividends are not antagonistic concepts but complementary ones. The entrepreneur must learn, from the outset, to distinguish between owning and managing. Many times, the owner also manages. Still, it is essential to keep the roles formally separate because that defines the money flows: the one who works receives a salary for his work, and the partner collects dividends if the company generates profits and if he decides not to reinvest them.
Not determining your economic compensation means not recognizing the high value of the entrepreneur’s work in entrepreneurship. It is a grave mistake to think that employee salaries or company expenses are more ‘valuable’ than their own time.
Who is who
The truth is that when this prejudice is overcome, and employers consult specialists on the subject, they often discover the importance of fixing their income, before a notary public, or through a protocol. The first recommendation, for companies with two or more partners, is to establish a “who is who”: what roles one fulfils and what percentage of the total investment corresponds to it.
Let’s take a hypothetical example: Harry Kane is an owner of a pub, and from the beginning of the established, he and his partner set how the investment and the work of the partners would be rewarded. They are two partners and Harry fulfil management functions throughout the day, so he charges a salary, while his partner, who is only in the morning, charges half.
The key is to distinguish between capital and management. The wealth belongs to the shareholder, who has the right to collect dividends as long as the company achieves the minimum established results. But when the management does not run on its own, it can be delegated to another person who can produce wealth from the control of the company. This person may receive their remuneration in the form of fees for holding Management positions at the Shareholders’ Meeting, prizes or bonuses tied to performance and dividends, after discounted resources reserved for countercyclical purposes or reinvestment in the business itself.
The confusion of money flows one of the most common pitfalls in family businesses. “It is essential to define the roles and, on that basis, decide the cash flows, so that the family members know that everything that is done in the company is fair, equitable and transparent. Otherwise, it falls into old vices, such as paying personal expenses with company accounts and cards and that nobody knows where it comes in, or where the money comes out.
Once the distribution of roles and responsibilities in the company has been formally determined, the compensation scheme is simplified. Ideally, apply a percentage of profits to partners, according to each shareholding, and pay the partner who works a market salary. It is in each company to set guidelines to make compensation more flexible according to the fluctuations of the economy or the market.
Of course, it is also advisable to “look” at the tax treatment that falls on the income of the entrepreneur, which experts say may have different effects on the company’s accounts.
While the payment of dividends is not deductible from the tax base for the company, the fees are subject to certain limitations. If it is only a passive investor and receives only dividends, the tax burden that entails is the 10% withholding that the company must make at the time of payment.
But the specialist clarifies that, in addition to having a percentage of assets, employers fulfil management tasks within the company. Fees or salary is made under the dependency relationship figure, but with the benefit of being able to opt for the regime of Autonomous social security.
This framework is beneficial for society since it must not make social contributions. However, in the Income Tax, the income received by that director-manager concerning dependency is subject to the regime of retention of salaries and fees.
Another fact to take into account is the possibility of establishing some flexibility clause in the remuneration received by the partners. Although there is no absolute consensus on the subject among specialists, it is more or less standard practice, with different formats, according to variables such as the progress of the business, the size of the company, or access to financing, among others.
When we are facing a period of lower sales, or when we have to face an investment, we don’t touch salaries, but we do cut the item that we will distribute.
If it is established, for example, that 25% of dividends will be withdrawn only when the after-tax profit is 19% on sales. Because if you take credit or decide to make an excellent investment, you will reduce the benefit on sales and, if maintained, of course, you can distribute dividends.
Not all family businesses work this way. On the contrary, it is quite common to find companies where partners request advances on account to change, for example, car or home.
It is one of the significant risks that family businesses run. The famous ‘today for me tomorrow for you.’ Sooner or later, the conflict starts there, and once the state of the internal debate has begun, the picture becomes uncertain.
In tune with the market
The decision to collect a salary from the entrepreneur with management functions presents advantages, such as greater transparency, but also risks. “If you allocate a wage in line with what the market pays when you stop working, the company can hire a manager to replace him in his role without restoring management costs. But, if you put a low or artificially high salary, you are masking inefficiencies.
In conclusion, it all comes down to a business owner’s situation. Both salary and dividends options have their pros and cons, and a respective decision can only be made after careful considerations and economic standpoint of one’s business in the longer run.