"Because I Deserve it" Isn't on Your Income Statement

I had a very interesting conversation with a small business owner the other day. We were reviewing his cash flow, and I noticed that his cash was dwindling at a quicker rate than normal, but his general overhead and payroll expenses weren't changing month-over-month. His sales were down about 25% from the year before, so the cash trend was worrisome to me. I then examined his Shareholder Dividends account, and noticed some drastic increases there. I had found my cash flow leak, and it was the owner.

So, I asked some questions, mostly because I was concerned that something personal had happened and he needed cash quickly. That’s never a good thing and I wanted to help.  

“I took that money out because I deserve it.”

What he said to me made me sit back and scratch my head.

I have to say, I've never heard anyone say that before. I’m sure people think it…heck, as business owners, we all think it sometimes. It’s just never been spoken.

“Why do you think you deserve that cash?” I asked.

“Because I took all the risk, I paid the taxes on the profit, and I’m not paying myself enough. Therefore, I deserve to take this money out,” he replied.

Well, I can’t argue with the fact that he took the risk. As entrepreneurs, that’s what we do when we start a new business. And since he is the sole shareholder, he also paid the taxes on the profit. He’s got me there. I had been on his case to raise his payroll a bit, but he hadn't done it yet because he hates paying Social Security and Medicare tax. He’ll never see a penny of that money, or so he says. But, it’s the word “deserve” that I have a problem with.

In the setting above, with less sales, less profit, and presumably less cash in the long run, did it make sense for the owner to deplete the cash because he “deserved” it? In this case, I argued that it wasn't a wise move.

I think dividends are dangerous to some S-Corporation shareholders. It looks like free money, but it’s not. I see companies get into cash flow trouble when the owner takes cash out of the company as a dividend, mostly because owners only read the Income Statement and they don’t show up there. Out of sight, out of mind. When we work with family businesses, we stress the importance of allocating profits for the future, for things like expansions or periods of time when cash is tight. In my client’s case here, cash flow could be tight before year-end if the sales trend continued, and where would he get cash to keep things moving?

I asked this question. “If you are sitting here in six months and sales are trending downward, and cash flow works out as we have projected, will you be comfortable firing 5 or 6 people to help ease your problem?”

His face drooped a little. “No, I don’t want to fire anyone. I can’t fire anyone. I’ll take less pay if I have to.”

But isn't that what you are doing now? How well is that working?

I looked at him over the rim of my glasses. “My advice is to start acting like that concerned boss today, and ease up on the dividend checks. I don’t see a “Because I Deserve It” account on your Income Statement. What I do see is “Payroll” and “Payroll Tax” line items. We can raise your pay slightly if you need more cash, but maybe we should talk about how you spend your personal money to make sure we don’t create a problem at your business in six months.”

I really hope I see progress when we meet again. When I checked up on him last week, he seemed to be upbeat since sales were up and he felt good about his personal cash position. He seemed more humble and less deserving. He and his team will reap the rewards of that change of heart.