Insight Associates provide outsourced accounting and Finance Director services to ambitious and growing businesses. We work as your only resource or with existing staff to give you complete financial support including monthly management accounts, high level financial advice, robust controls and financial systems, funding and business planning, payroll & compliance, VAT returns and statutory compliance.

Successful business leaders have all the information they need to make good decisions…Do You?

Thursday, August 17, 2017

When to spend your business’s spare cash

When Thelma and I were first married, we were both earning good salaries. We put some money aside each month, and soon we were able to move from our maisonette straight into a big family house. 

We missed out the stepping stone of buying a smaller house first, and it stretched us financially. But we felt confident we could do it.  

We were both in our 20s, and the alternative was to spend on amazing holidays, eating out regularly and partying. It would have been fun, but we preferred to take a long-term view.

I sometimes think about the choices we made then when I’m talking to clients about what they should do with any spare cash they have in their business. If you’re profitable, it’s a decision you’ll have to take sooner or later. 

The choice is whether to take all or some of it out of the business to spend on yourself and your family, or leave it all in the business and invest it right back in. 

After a good year, it can be tempting to take out money out of your business to use personally – and that’s not necessarily the wrong choice. Perhaps you need to take money out of the business to move house because of a growing family. Or do up your home – often a wise investment. Everybody has important priorities.

But you should never, ever do it without first gaining a proper understanding of what funding your business will need over the next few years. It would be a terrible mistake to drain your business of money it needs to grow (and make you even more money….). 

“Spare” cash must really be spare – not money your business needs.

The key is good financial planning. If you know where business is heading and what kind of investment you are going to need to get it there, what to do with your spare cash will be decided for you. 

There is another argument for leaving the money in your business. Not only will leaving money in place make the company stronger – it will make it look stronger, too, when customers or suppliers do credit checks. 

Credit companies want to see the value of the business increasing, and that means they want to see cash and resources growing. If you take out all your profit, from a financial point of view it’ll be as if the company hasn’t made any progress from one year to the next. 

In a personal context, everyone agrees it’s better to put some money aside if possible. It’s the same for your business. You will be more comfortable knowing that there is some cash in the bank to cover your business in the case of emergency, or to take advantage of opportunities that arise. 

So try and act strategically. 

It was certainly the right approach with our house, all those years ago. The temptation to spend the money on the ‘here and now’ was massive, but 30 years down the line, our investment paid off. We’re still in the same house.

And with the kids having flown the nest we’ve now got some spare cash again. 

If you want help determining what kind of cash your business will need to grow over the next few years, let’s talk. We can help you set clear goals for your business, and create a realistic budget to achieve them. 

You will know exactly how much money you can take out of the business for yourself and for your family, and how much you need to leave in your business to make sure it grows…

Having your financial cake – and eating it too

I know a business which lost 60% of its turnover in a year. It sounds calamitous, but it’d been running very profitably for 15 years, and most of the value it had built up was still there as cash.

The owner had never had to make any big investments in his personal life, so he just paid himself a salary – a perfectly decent one, but not large. All the ‘super-profits’ which his business was making over all those years were just left sitting in the company. 

If and when he comes to sell it, its value will be significant – despite the recent downturn in the business’s fortunes.

Keeping that much money in your business isn’t a route I’d recommend to everyone. But it does illustrate the choice you have, if you are intending to exit your business one day.

You can have the cash now, as you’re building the business; or you can have the cash later, when you sell it. You can’t have both.

It’s perfectly reasonable to want the cash now, and pay yourself a massive salary or dividends each year. It won’t necessarily kill your business: A successful company will keep on creating value.

But you have to remember that any cash you take out now won’t be there when you come to sell it, so the business will be worth less at that stage. The value that the business has created over the full term will be more or less the same, it’s just that you’ll have taken some of that value out early. 

If you were relying on a humungous payday when you sell your company to fund your retirement, that won’t happen.

If, on the other hand, you want that final sale to be as large as possible, it’s better to take a smaller salary as you’re growing the business. Many people take very modest salaries when they’re starting up, while later their pay may be more in line with what they’d expect as an employee. (Perhaps a well-paid employee…)

Anything above that might be called super-earnings.

When I have conversations with clients thinking about taking super-earnings, I try and make sure they have solid reasons. What are they planning to do with the extra money? 

There’s nothing wrong with deciding to benefit from your business’s extra cash as you go along. But you have to remember: there will be consequences when you to come to sell.
It all depends on your long-term priorities and strategy (and of course if you have several owners all with different strategies, it will be an extremely complex decision!). 

The million-dollar questions are: 
     What’s your big plan? 
     What do you really want out of your business, now and in the future? 
     How much value do you need in your business, when you sell it?

Just remember, you can’t have your cake and eat it too.

If you would like help figuring out the long-term plan for your business, and ensuring that it fits your financial needs, hit ‘reply’ and let’s talk.

A tale of two purchases

Recently I mentioned that companies need to be very agile because, in our fast-paced society, opportunities can present themselves very suddenly. 

Here’s a tale of two purchases I was recently involved in.

In the first case, the competitor of a client of ours went into administration, and was looking for a buyer. In cases like that, the sale is likely to happen very fast.

Our client understood that this was a brilliant opportunity to make a good purchase at a good price. 

It was a big decision, but they had decent cash reserves, and would only be risking 20%. 
They were able to act quickly and secure the deal they wanted.

In the second case, I saw a similar story from the other side. This time, it was one of our clients that was looking to sell off part of their own business. 

I was brokering a deal with a larger competitor, a company which was substantially indebted. And that meant that when they went to the bank to borrow the money they needed, the bank said no – and the deal was off.

Why was one company able to take advantage of the opportunity which fell into its lap, while the other company was not?

Simple. The former had spare cash, the latter didn’t. 

It sounds obvious, but just like you need savings in your private life, your business needs savings too.

It can be crucial in exploiting all kinds of opportunities – not just buying companies. There might be a chance to go into a new market for instance, or buy stock at a discounted price.

And if it’s not an opportunity which comes your way but a threat or a disaster, that cash can be the cushion in your system. You need to put money away for that rainy day. 

Now, you may be thinking: “But we don’t have any spare cash!” or (if you’re the business owner), “Any spare cash we have is going straight into my pocket…..”

It’s important to realise that having cash doesn’t necessarily mean having money in the bank. Cash can also mean arranging ready access to credit lines. 

That credit doesn’t have to come from a bank or whoever’s financing your business. It could be from, say, factoring or crowd funding. But wherever it comes from, you should make sure it’s available for when you need it. 

If you already have access to debt (hopefully for a good reason, to invest in your company’s future – not to prop it up when it fails!), keep some powder dry. So if you really need a £0.5m facility, get double that, so you can have some room to manoeuvre when opportunities present themselves.

I’ve seen too many owners think that because their business is doing well they don’t need to think about putting aside spare cash. But of course it’s much easier to set up a credit line when you're thriving, rather than rushing to the bank at the last minute, cap-in-hand. 

Having the credit doesn’t mean you have to use the money. It’s just good financial management to have access to cash when you really need it.

If that’s something you’d like in place let’s talk. Whether you already have spare cash and need to work out the best thing to do with it, or whether you want to manage your finances better so that spare cash becomes available, we’d be delighted to help.

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