Turning a profit as a company is clearly one of the foundational aspirations of any new startup or small business. Without a profit, you don’t have a workable business model, after all. But once you’ve generated a profit, what do you then do with this surplus revenue?
The temptation, as the owner or directors, is to award yourself a fat dividend payment and enjoy the return on your initial time, effort and financial investment. But there are a number of reasons why reinvesting your profits back into the business is the most productive route.
Why should I reinvest?
For your business to stabilise and grow, you’ll need the requisite working capital and growth budget to fund your expansion. You can, of course, look for additional investment or access to third-party finance to do this, but there’s an easier way – reinvesting your profits.
If you’ve got plenty of money sat in the profit pot, use this cash to fund your own growth and development. Paying this money to yourself and your company shareholders may pay for your next Carribean holiday, but it does nothing to add value to your business.
There’s also the added problem of income tax – as soon as company profits are paid out to you and your fellow directors, you’re liable to pay income tax on these earnings. So, taking too much cash out of the business can actually end up costing you money.
As a general rule, it’s good practice to only take out the profits you actually need, and to leave as much of your surplus income as possible sat in the company bank accounts.
When is the business ready reinvest?
If reinvesting is the ideal solution for your SME profits, how do you know when the company is ready to start making use of the cash that’s currently locked up in the business?
There are a few key considerations here:
Ensure you’re in a positive cashflow position – a company can appear profitable, while still experiencing poor cashflow. Profits are the surplus income you’re left with, whereas cashflow is the process of balancing your immediate cash inflows and outflows. So make sure you have the requisite cash in the business to remain financially stable and cashflow positive before reinvesting any of your existing cash.
Know your profits numbers – before you start syphoning money off into reinvestment projects, it’s important to have a proper overview of your profitability. Profit forecasts are helpful, but, ultimately, you should be reviewing your profit and loss statement (P&L) and basing any reinvestment on profit actuals – i.e. on the money you’ve already generated and have sat in the bank.
Forecast the immediate future – no one knows exactly what the future holds, but running regular profit and cashflow forecasts and projections will help you to understand the upcoming financial path of the business – exposing any potential cash gaps that may require filling, and which will take priority over your reinvestment plans.
Draw up clear budgets – once you’ve identified areas of the business that will benefit from reinvestment, be sure to draw up defined budgets for each area of investment. Rather than simply throwing money at an opportunity, make a concerted effort to factor in the costs and expenses and draw up a budget limit to stick to.
What key business areas should I invest in?
Knowing where to reinvest your profits can be a challenge. With cash burning a hole in your pocket, the temptation is to throw money at any pre-existing problems, or to assign a budget to the department that shouts loudest and hardest.
But, in the long term, you’ll get more inherent value from your reinvestment if there’s some robust, strategic thinking behind your choices. Ultimately, any money you invest back into the company needs to have a clear business purpose, so think long and hard about your aims, the costs and the potential return on investment (ROI) that you may see.
Some core areas where reinvestment can add value will include:
Hiring more people – to grow, you need a bigger workforce, so it’s common to reinvest your profits into creating more roles, hiring more talent and expanding your team so you’re ready for the process of scaling up the company.
Invest in education and training – to meet future challenges, your existing staff and team will benefit from continuing professional development. With additional training and support, you’ll expand the talent and capabilities of the whole workforce.
Buying more equipment and assets – as the company expands your operational resources will need to grow at the same rate. To scale up these operations you need more equipment, more machinery and more tools, all of which requires investment.
Moving to larger premises – bigger aspirations require bigger premises, giving you the floor space to expand effectively. As such, leasing or buying larger offices and workspaces is a popular way to reinvest your company profits.
Expanding your marketing activity – more marketing = more enquiries = more sales. So pouring money into expanded digital marketing, paid advertising and social media activity is an effective way to raise brand awareness and boost sales and revenue.
Investing in R&D – research and development (R&D) keeps your company at the cutting edge and helps keep you competitive. Investing in targeted R&D activity helps you create new products and/or services – and if you meet the criteria for the current R&D tax credit, you can also help to cut your corporation tax bill.
How do I invest what’s left over?
Not all of your profits will end up going into reinvestment. As we’ve already mentioned, some of those hard-earned profits will be paid out as dividends to the company’s shareholders. And some of those profits will get used up on general expenses and operational costs.
But once you’ve assigned your reinvestment budgets and divided up the profit cake into the agreed slices, what do you do with the money that’s left over?
Leave it in your cash reserves – setting aside cash reserves ‘for a rainy day’ is prudent, so one answer is to simply leave your surplus profits sat in the company bank account. You won’t earn much interest, but it does give you fast access to liquid cash.
Invest in financial vehicles – if creating a healthy return from your profits is important, there are plenty of investment vehicles that you can put your money into. Whether you opt for a portfolio of your own bonds, stocks and shares, or put the money into an investment fund, it’s worth remembering that the value of your investments can decrease as well as increase – so make sure you consider the potential risks and opportunities.
Invest in property – putting your cash into bricks and mortar can kill two birds with one stone. Buying a property gives you a building to work from and provides you with an investment opportunity – as long as the value of your property increases, of course.
Invest in other businesses – providing an equity investment for an early stage startup is one way to get a return on your money, while also helping another business to get off the ground. You’ll obviously need to ensure any business you invest in has a solid plan for success, but by investing capital you’ll benefit from any profits they make.
Making your money work harder
To make reinvestment and investment work effectively, it’s crucial to have tight control over your finances. With a good accounting set-up, regular real-time reporting and forecasts around your cashflow, debt and profit position, you’re in the best shape to start investing any profits.
More than anything, reinvesting back into your business is something that secures your long-term future as a company. So, start reviewing your profits, planning out your reinvestment and set the wheels in motion for the next chapter in your business story.
The Fluidly blog has lots more tips for getting the best from your company’s finances.
