There’s no better feeling than the satisfaction that comes from growing a healthy profit margin at your small business. If you’ve reached the stage in your business life cycle where your revenue is more than covering your expenses, congratulations. Your hard work is paying off!
However, there is such a thing as “too much” profit, such as when there are excess funds in your bank account that could be used to generate additional income.
“By keeping the cash idle, the business loses an opportunity to generate additional returns,” wrote Small Business Chronicle. “Therefore, the major disadvantage of too much cash on hand is that it lowers the return on assets.”
If you have money sitting in your small business bank account, there are ways to invest it. However, these investment options have tax and other business implications. Here’s what you need to know about investing your SMB earnings.
What are some ways to invest small business earnings?
Just as there are many ways to invest your personal finances, there are a number of options for investing your business’s earnings. Each comes with a different level of risk and potential reward. Here are a few examples of things in which you could invest.
[Read more: One Quarter of Small Businesses Plan to Reinvest in their Enterprise]
Build emergency funds or reserves
Some experts recommend shoring up savings in an emergency or rainy day fund before expanding your investment outlook to any of the options listed below. Most experts suggest shoring up six months of operating expenses that you keep separate from your regular business account.
To set up an emergency fund, consider moving cash from your business checking account into a different, low-risk financial vehicle. “A cash reserve isn't always just money in a checking or savings account. Some businesses may also supplement their cash reserves with three-month Treasury bills or other short-term assets,” wrote QuickBooks.
A financial advisor might also recommend low-risk municipal bonds and short-term CDs (certificates of deposit). If you’re not familiar with bonds or CDs, speak to your bank about opening a savings account for your small business.
Repay existing debt
Next, many business owners, at some point in their business lifecycle, use debt to get their operation off the ground or to expand to a new market. If this is your first venture, there’s a good chance you may have a relatively high interest rate. Excess profit can be used to refinance or pay down some of your existing debt, which will save you money in the long run. However, if your interest rate is more favorable, you may want to invest your earnings elsewhere to optimize how you’re utilizing your profit.
Marketing or employee training
One way to make use of a profit is to reinvest it back into your business. Many business owners, for instance, use earnings to try to reach new customers through marketing campaigns or advertising. Other merchants invest in their employees with training or professional development. Both options allow you to build upon your existing success in a way that’s low-risk and potentially high-reward.
Your business's classification—whether it’s an LLC, for example—will help dictate where and how much you can spend in certain areas.PNC
Purchase new equipment
In addition to helping your business grow, the purchase of new equipment can be used to reduce your tax burden at the end of the year. Maybe that means investing in a new espresso maker at your cafe, or providing employees with new headsets to work from home. Any assets you choose to purchase should be beneficial to serving your customers, working effectively, and helping your business grow.
[Read more: A Complete Guide to Filing Your Business Taxes]
Equities or bonds
Lastly, small businesses can use their earnings to buy equities or bonds. The method for doing so depends on how your business is structured. “An LLC's operating agreement can give just one of the owners/managers the authority to purchase stock on behalf of the company, or it may give this power to several or all of the parties involved,” explained The Fool.
S-corp and C-corp companies can also buy equities, but be aware that any capital gains will be taxed. Bonds are less risky, but they also typically have a lower return. Speak to a tax professional who can help you understand the financial obligations that you may face—both personally and as a business—by investing company earnings in equities or bonds.
Short-term vs. long-term investment strategies
Creating an investment strategy for your small business starts with assessing your short-term and long-term priorities. Your investments should balance your immediate operational needs (and liquidity in case of emergency) with long-term value creation.
“Creating a robust investment approach requires more than just selecting various investment vehicles,” wrote PNC. “Your strategy should reflect both your business lifecycle stage and long-term objectives while accounting for your industry's specific challenges and opportunities.”
Experts also suggest investing in assets that complement your industry’s risk profile. It would be a mistake, for instance, for a retailer to invest in consumer spending equities; the markets are similar enough that if there’s a downturn in one, it will impact the investment in the other.
Short-term investments are defined as those that can easily be converted to cash within a five-year time frame. They are flexible and accessible: think high-yield savings accounts, certificates of deposit, treasury bills, and money market funds.
Long-term investment options to explore include real estate, equities and bonds, and even investing in other businesses. Speak to an advisor who can guide you on what options are available based on your budget and goals.
How much profit should be reinvested?
PNC Bank experts recommend reinvesting between 20% and 70% of your profits back into your business. This broad range encompasses several considerations. For instance, how much does your business owe in taxes? How much will you pay in additional taxes based on your reinvestment?
Likewise, some laws govern how you spend the money you bring in from your business. “Your business's classification—whether it’s an LLC, for example—will help dictate where and how much you can spend in certain areas,” wrote PNC.
Your business goals will also impact how much you choose to reinvest. A business expansion is more expensive than buying a new POS for your store to improve the customer experience. Assess your goals and how much you need to get there, then reach out to a financial advisor for help.
CO— aims to bring you inspiration from leading respected experts. However, before making any business decision, you should consult a professional who can advise you based on your individual situation.
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