What should I do with extra business cash?

What should I do with extra business cash?

This content is for information and inspiration purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice please consult us here at Wealth Solutions in our Edgbaston or Warwick offices.

How should you invest the profits of a small business? There is a wide range of options from holding in cash, to investing in your team through to buying another business. Yet how can you settle on your choices? After all, getting the decision wrong could negatively impact business stability and growth. In this guide, our financial planners at Wealth Solutions outline some key guiding principles to help guide what to do with extra business cash. We hope this is helpful to you. If you’d like to speak to an independent financial adviser then you can reach us via:

T: Edgbaston 0121 446 5815
T: Warwick 01926 888091
E: [email protected]

Check your business protection

Before a ship sets sail, it is important to batten down the hatches. Similarly, before a business charges ahead with using profits to grow, the directors should make sure that key provisions are in place (i.e. financial protection) to keep everything on course if things go wrong.

For instance, what might happen if one – or more – of your key people suddenly died? The death of a director, for instance, results in his/her shares falling into the hands of beneficiaries when the estate is administered.

Without a pre-existing agreement and lump sum at the ready to buy the share(s) back, this could leave some of the business in the hands of people who do not know – or care – about it. Here, you could use some of your profits to invest in shareholder protection to ensure that the share(s) can be bought back if a director dies.

Create a cash buffer

The COVID-19 pandemic in 2020 was a hard lesson for many businesses. With millions suddenly under strict lockdown, many SMEs and sole traders struggled to keep going – even with government financial support. Those which had already built up a “rainy day” fund, in anticipation of possible hard times ahead, likely fared better than those which had not.

Of course, your business insurance policies should cover the major disasters, it is a good idea to have liquidity on-hand as a safety net (e.g. 6+ months) for problems that are not insured. However, be careful not to hold significant amounts in cash. This is an inefficient use of capital and is not a panacea for overspending.

Reward your shareholders

When profits are strong, it can be a good idea to distribute some of it to shareholders as a dividend. This helps create goodwill amongst your investors and can encourage further future investment. However, during hard economic conditions and/or times of shrinking profits, it may be worth reducing or even suspending a dividend for a season. This frees up more cash to put towards an emergency reserve and covering liabilities. However, clear communication with the shareholders will be key to avoid creating ill feelings – or investor flight.

Buy another business

There are two main ways to finance the purchase of another business: through equity or debt. The advantage of the former is that credit (a liability) is not needed, but it can take time to raise the capital from profits. Using debt is typically faster but also adds extra cost in the form of loan repayments (where interest eats into the returns of your investment).

In some cases, debt can be more tax-efficient as it can be treated as an expense – reducing your corporation tax bill. Yet using cash can present a healthier balance sheet to potential investors. Regardless, make sure that any business purchase is strategically wise. For instance, if your overall marketing strategy is to diversify your profits to a new customer base, will this business purchase help with that – or distract?

Pay down or re-finance debt

For those businesses saddled with debt (e.g. new businesses which used loans to get started), a healthy dose of profits can help significantly with lowering your expenses. Startups often need to borrow at a high rate of interest, for example, which inhibits their growth potential.

Here, it can make more sense to refinance at a lower interest rate – rather than making a large payment towards the principal balance – if you can demonstrate that your default risk has gone down. However, repaying the principal can help your business save more money in the long run.

Improve the business

If you are in a more comfortable business – e.g. your debt is under control and you have a good “rainy day fund” – then you could use profits to help improve your business efficiency. As the old saying goes, sometimes you need to spend money to make more money. For instance, perhaps you could invest in new machinery to produce your products. Whilst the initial outlay to buy and install the equipment may be quite high, over its lifetime it could be worth the cost if the savings (e.g. in power) are likely to exceed this.

Invitation

We hope this content has been informative and inspired you to develop your own financial plan. Please get in touch if you’d like to discuss these matters with us via a free, no-commitment consultation with a member of our team:

T: 0121 446 5815
E: [email protected]

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