Should business owners reinvest their profits or save them?
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At some point or another, if you run a business, you will encounter the above-mentioned dilemma. What do you do with a surplus of profit? If you already have an emergency fund stashed away and you have no outstanding debt, it can be tricky. Cashing out to use it on yourself feels a little self-indulgent, so maybe reinvesting back into the business is the right call?
Data from the U.S. Chamber of Commerce notes that 33% of business owners are not comfortable with their level of cash flow. Likewise 38% of small businesses failed because of a lack of capital.
In this article, we will walk you through different aspects to consider so that you can come up with a clear surplus fund usage strategy. Let’s jump right in.
Understand what profit actually means
First of all, it’s important that you’re 100% confident that you have surplus cash. Many owners wrongly assume that profit is extra money. They forget that some of it will have to go for taxes or payroll cushions.
As Investopedia highlights, in some expensive states like California, businesses might have to pay an 8.84% flat tax on income. For comparison, New Jersey has an even higher rate of 11.5% while North Carolina sits at a comfortable 2.5% (the lowest in the country).
So, if you are sure that what you have is surplus money that’s left after tax takes its cut, read on.
Profit can be used toward a number of business objectives. Firstly, you can use it as fuel to grow via reinvesting. Secondly, you can save it to be your insurance against market dips. Thirdly, you can use it as leverage to show investors and banks that you are not a liability. Thinking about your profit on these three lines can be helpful as you now have a structure to base your decisions on.
Consider the third option: Borrowing
Some entrepreneurs believe that a nice way to use profits is for purposes like upgrading equipment that will improve productivity. While the idea is legitimate, you don’t have to use your profits for it. If your business is successful enough that you have extra profit lying around, you won’t have any issues borrowing money.
The U.S. Federal Reserve notes that 37% of small businesses applied for either a loan, line of credit, or merchant cash advance. 50% of these businesses applied for a total of $100,000 or less, and 30% applied for $50,000 or less in total.
There are many alternative lenders that offer fast cash for business owners, even if they lack a business history. This is a common situation for many entrepreneurs. They can definitely pay back lenders, no problem, but they lack the eligibility criteria that traditional lenders want. This is why more and more people are moving to alternative lenders.
As Fast Business Financial notes, online lenders tend to prioritize aspects like your overall business health and cash flow instead of just credit scores. The key benefit of borrowing instead of using your surplus funds is that you protect your liquidity. This is a massive bonus that shouldn’t be overlooked because if your surplus is big enough, you might even be able to borrow against it
Understand when saving makes more sense
Reinvesting, whether that be with your surplus or with loans, does make sense most of the time. That said, there are some situations where saving can be the better choice. For instance, if you’re in an industry that’s going through some volatility, then investing in growth can be a high-risk move.
Likewise, another scenario where saving makes more sense is if your personal wealth is extensively tied up with your business. This is also referred to as having high personal financial exposure, which can be another form of liability.
Another way of looking at not spending your surplus is to realize you are still investing, but toward stability and more options. You are investing in the opportunity to use your money later. This also means you should always be considering the best use of your funds in the future and try to develop proper budget plans.
Ultimately, there isn’t one definite correct answer between investing vs. saving because it depends on your specific situation. So many factors exist, and it’s likely that through the years, you will go back and forth between reinvesting and saving.
You’ll likely face several other dilemmas like these as a business owner, and that’s part of the process. Look at the bright side, you did well enough that your problem is finding out how to spend your money. Now, that’s a dilemma many entrepreneurs wish they had.