Every business is unique and what you do with your money is obviously a personal decision. The following information represents a top-level review of some of the options you might consider.
There may be no better “problem” to face than trying to figure out what to do with your company profits. The answer depends to a great degree on how your business is organized. This article focuses on small businesses that operate as sole proprietorships or limited liability companies.
One temptation, especially at the beginning, is to pour much of what you make back into the business. That can work for awhile if you have adequate savings to live on, but the goal should be to break out of that mode as rapidly as possible. If you don’t, you’ll fool yourself into believing that your business is successful when it actually may not be. That’s because your salary isn’t factored into the cost of doing business.
Pay yourself at least what you need to get by, and lay the groundwork for paying what you’re really worth. You should be able to increase your pay at least as much as your growth rate without impacting your bottom line. Start a tax-deferred savings plan as soon as possible and maximize your contributions.
Pay down debt.
In today’s low interest rate environment, it may not make sense to pay down debt more rapidly than the minimum needed. If you’re carrying a high interest rate on an old loan, now’s the time to renegotiate that loan with better terms. That will allow you to reduce the principal more quickly and perhaps shorten the payback period.
When analyzing how much to allocate to debt payments, it’s important to consider the tax implications of each option you’re considering. While paying down debt early will reduce the total interest expense, you should focus on what impact that will have on your annual bottom line.
Consider using some of your profit to improve your facilities and equipment. These could include better office space, computer and software upgrades, more office supplies, new furniture, and other tools to increase operating efficiencies. Review your insurance policies and make sure the coverages are adjusted to any changes in potential liabilities.
If your sales outlook is favorable and you can handle the storage, build up your inventory of raw materials and finished products. You’ll be in a better position to respond to unexpected sales growth and demand spikes due to holidays.
If things are really going well, think about giving back to the community. It’s not only a good idea, it will likely benefit you in the long run. Sponsor a youth sports team and put your company name and logo on the uniforms. Participate and donate to local groups devoted to community development and enhancement.
If expansion is part of your business plan, profit is a practical source of financing. It doesn’t cost you anything and doesn’t increase your debt load. Before taking that approach, reevaluate your plan and business projections to make sure it’s worth more investment. If interest rates are low, a bank loan may be a better option. Analyze your cash flow and tax consequences as part of your decision-making process.
Another option is to acquire an existing business that complements yours. The combination will likely lead to greater efficiencies and a lower overall cost of doing business. It will also eliminate whatever competition existed between the two companies.
If you decide to expand, you’re going to need help to facilitate that growth. Before taking that step, take a hard look at how you’re spending your time. If some or most of your day is taken up by tasks that could be delegated, that time could be better spent on critical tasks and big picture thinking.
For small business owners, hiring people is a major decision that requires thoughtful consideration. Here’s a general checklist for determining how it will impact you financially:
• Review estimated future sales volume and how this will affect your time and ability to meet all your commitments
• Clearly define the expected tasks and responsibilities of the new job
• Calculate the amount of revenue the new employee will add to your bottom line
• Calculate the total expense of hiring, training, paying, benefits, taxes, and providing workspace and equipment for the new employee
• If the generated revenue exceeds the expense, and your expected cash flow is sufficient, that’s a signal that you can afford to hire
• If you’re hiring someone for sales, you can pay them on a commission basis to limit your upfront exposure
• If you can’t hire someone full time based on this analysis, consider hiring part-time help or outsourcing to a contract labor pool
Also consider the intangible benefits of hiring that may be hard to quantify in dollar terms. You’ll be under less pressure and have more time to focus on customer service, marketing, quality improvement, and other efforts to attract more attention to your business.
Many businesses start out as sole proprietorships, but find that this form of business isn’t the best over the long run. Two of the primary drivers behind changing the form are tax and liability issues. There are several advantages of incorporation including the use of a custom fiscal year, zeroing out the company’s income, awarding stock options, deferring compensation, and staggering bonuses.
Over time you can change your form of business to maximize profits and minimize taxes and risk. Take advantage of this to the greatest extent possible.
Consult with an accountant or tax attorney before you make consequential decisions about how to use your profit or change your form of business. Everything you do with your money has tax consequences and you want to make sure they’re factored into the decision-making process.
Finally, why not use some of that profit to reward yourself? Take that vacation you’ve dreamed about but haven’t had time for. If you have employees, put something extra in their next paycheck and think about a profit-sharing arrangement for them. And don’t forget to stash some cash in a rainy day fund. You never know when you might need to dip into your reserves.