Business profits are great to have, but they are even more valuable when you use them to further your financial success either by paying down debt or investing.
The United States is jam-packed with small businesses, home to 31.7 million of them as of 2020. Despite their importance on the national economy, many businesses fail soon after starting, quickly being replaced by prospective entrepreneurs. According to the U.S. Bureau of Labor Statistics, roughly half of all businesses fail within five years. Handling your business profits well is directly related to sustaining success. Let’s discuss how to manage your cash surplus.
What should you do with business profits?
If this is a cash surplus, there are several business profits strategies you can use. As you know, cash is the lifeblood of business. You use cash to maintain inventory, buy supplies, pay workers — pretty much everything. Consistently having a cash surplus feels great as a business owner. Although keeping this cash around might provide comfort, you should always keep your bankroll in action.
Paying debt — The reliable, proven option
Paying down debt, reinvesting in the business, and investing in the stock market etc are the three top uses of a business profits cash surplus. Without fail, paying debt almost always takes precedence over investing. Whether it be mortgages or lines of credit, debt accumulates interest faster than investments. In general, any investments that claim to yield higher interest rates than your outstanding debt are highly risky.
According to Nav, traditional bank loans typically sport annual interest rates between 2% and 13%. SBA loans, another popular form of business lending, have interest rates between 7.75% and 10.25%. Since most worthwhile investments don’t yield more return than these loans, you should pay your debt before considering investing. However, prepayment penalties could give you a valid reason to invest.
The SBA’s 7(a) loan program is the federal agency’s most popular lending setup. Under this program, if you pay 25% of your loan’s balance within the first three years, you face prepayment fees. Traditional bank loans may also enforce prepayment penalties.
Reinvesting business profits back into the business
Basically, the economy only grows when profits are reinvested and not immediately paid out to the respective owners. As the economy grows, so does the company in the long term, of course. If a little patience is applied, everyone ultimately benefits, and profits are not only secured, but also usually increased if the company is managed carefully .
These advantages are reason enough to examine this topic in more detail below. However, it is not just about the reinvestment strategy in relation to companies. Even when trading stocks, this leads to long-term profit protection and ultimately to greater success, which is why this is also one of the relevant topics of reinvestment.
Reinvestment means that the business profits income released by the management of the company is reinvested in it. If a surplus is achieved, management has to choose between two scenarios. The profits are either paid out to the owners or reinvested in the business to improve it.
Statistics from the Chamber of Labor show that most companies opt for a very high profit distribution. This is extremely worrying, especially in economically unstable times such as the prevailing one, as it is important to strengthen the company with equity and not weaken it with any debt capital that may be required.
Tips for sensible reinvestment
This can for example take place in unusable equipment being replaced, such as machinery, equipment and buildings. As a result, the capacity is ultimately expanded and there is an increase in business profits in the long term.
Intangible investments are also worthwhile business profits reinvestment. Popular here are, for example, further training measures for employees or the offer of training measures, such as apprenticeships. This motivates employees to commit themselves to the company in the long term. A high number of skilled workers also ensures a good reputation for the company and increases the prospect of economic success and higher income.
Another type of intangible investment are profits that are used to finance advertising for the company. Increased awareness will also benefit in the long term.
Another keyword is: future investments . Funds that go into research, development and innovation are never wasted. They usually give the company a long-term advantage over its competitors. Those who convince with innovative products are usually among the market leaders. However, it is precisely here that you have to be patient. It can sometimes take a long time until the first research results are available that actually benefit the company. In the end, however, stamina is almost always rewarded with high returns.
Reinvesting business profits avoids the company’s increased need for outside capital. Borrowed capital is expensive because it has to be paid back together with interest. Of course, this inevitably means that future surpluses of the company have to be used to finance the debt, an expense that does not arise with used equity.
Investing: essential investment characteristics
We can define financial instruments with hundreds of terms. In their most basic form, business profits investment descriptors can be broken down into four areas: risk, liquidity, maturity, and yield.
Risk and yield
As a business owner, you’re probably geared toward long-term sustainability. Unless you’re a serial entrepreneur creating startups with the intention of selling them in a few years, avoiding risk is essential to success. By definition, low-risk investments confine you to relatively low yields.
Maturity
SBA loans’ prepayment fees don’t apply after the first three years. Since you can start paying these loans off after their third birthday, don’t invest in opportunities that take longer than three years to pay off.
Liquidity
High-liquidity investments are easy to convert into cash you can use. You should avoid investing unless you’re confident that you won’t need to cash out before maturity.
Suitable investment options for business owners
Here are some of the top investment options for business owners:
Cryptocurrency
Admittedly, cryptocurrencies are volatile. This means they’re associated with moderate to high risk. However, they can earn serious value in very little time. Business owners that can accept the risk level with a portion of their profit can see significant returns on the investment. OKEx is a cryptocurrency exchange that allows business owners to quickly buy and sell crypto assets like Bitcoin. This is also a very liquid asset which is great if you need to convert the asset to cash quickly.
Certificates of deposit
Banks offer premiums to investors in exchange for holding lump sums of cash for a set length of time. Although interest rates are low, CDs are highly secure.
Treasury notes and bills
The U.S. Department of the Treasury offers Treasury bills and notes. Bills last for three, six, or 12 months. Notes last two, three, five, seven, or 10 years. With reliable payout dates, Treasury-backed securities might be ideal for your business.
Sweep accounts
These bank accounts combine money market accounts and checking accounts, helping you earn additional interest with your cash surplus. They automatically invest any balance over their required minimum balances, offering a no-worry investment option.