Where to Invest Your Small Business Profits — And Why
September 30, 2019
September 30, 2019
Whether you are running a new business or a generational family business, as a small business owner, there is no greater feeling than when you take a look at the balance sheet and see your business’ net profits are climbing. This is the sign that you are running a successful business and that your business plan is working.
But now that you are making profits, what should you do with them? What areas should you invest in? New employees? Interest-bearing bank accounts? Index funds or mutual funds? Somewhere else?
In this post, we’ll cover the various options your business has for investing its profits as well as why these options ccan benefit your business in both the short term and long term.
Investing small business profits is an important aspect of running a successful business because it allows owners to drive future and sustainable growth. Profits are financial resources your business has already earned, meaning they are not obtained from a loan and your business has no financial liability for them. Reinvesting profits can help you build a positive feedback cycle for your company: Reinvesting profits leads to business growth, which leads to increased profits, which leads to increased reinvestment, which leads to increased business, which leads to increased profits, and so on.
Obviously, the goal of operating any small business is to make money, and many business owners start small businesses because of the appeal of self employment in the first place. As such, paying yourself is an essential component of net profit allocation.
However, while you should be paying yourself the proper amount of money to cover your living expenses and additional lifestyle choices, you should also try to refrain from taking net profits exceeding your typical annual living expenses. This also means you shouldn’t continually change your lifestyle to make use of extra business profits.
This is a common mistake a lot of people who own businesses make. By making sure you leave some profits for reinvesting in your business, you can help facilitate the future growth we’ll discuss below. Just $1,000 can make a huge difference when it comes to reinvesting, so always ask yourself, “Do I really need all the money I am taking out of the business?”
You have myriad options for reinvesting small business profits. Below, we’ll discuss some. First, however, know that it can be helpful to include your plans for business reinvestment in your business model. This way, you can set clear goals toward your future net profits.
Take time to consider questions like:
By putting thoughts into these questions early on, and developing a business model and plan for the future, you can make sure that you are not reinvesting in arbitrary, unrelated, and disjointed aspects of your business. You should aim to make sure your reinvesting serves a greater purpose in the grand scheme of your business. A good catch-all question is, “How will reinvesting in this area of my business affect my business in 5 to 10 years?”
Business infrastructure and equipment is a common reinvestment category for small businesses. Updating your business’s equipment and infrastructure when it is advantageous can allow your business to grow. Many times, buying new equipment or updating the company’s infrastructure will allow you to better meet the needs of your customers or business, thereby improving efficiency and/or customer experience.
For example, let’s say you own a coffee shop. Your coffee shop is doing well and your net profit is growing. In fact, your coffee shop has become so popular that it often has a line out the door. At first, you may think this line is positive, but then you realize it’s actually turning away customers who don’t want to have to wait in such a long line. You realize that it’s the capacity of your coffee machines that is causing the problem, not the number of employees. By using profits to buy better, higher capacity equipment, you can increase the number of coffees you can make, shorten the line, drive up business, increase profits, and grow your business! Sounds great, doesn’t it?
Obviously, this example is ideal, and not every scenario will be that cut and dried. But, it provides a window into the fact that reinvesting in business infrastructure and equipment can help take your small business to the next level simply by removing limiting factors — in this case, the number of coffees you can serve in an hour.
As a note of caution, you should make sure that whenever you update equipment it is either necessary or will be beneficial. It is not always necessary to have the latest and greatest machinery, so make sure you are not wasting valuable profits that could be spent more effectively elsewhere.
It’s almost never the wrong time to invest in marketing. Marketing is an extremely important aspect of driving business growth and leading potential customers to your website or place of business. Whether through hiring a social media consultant, investing in an ad campaign, or contracting a graphic designer to create compelling and aesthetically pleasing flyers, reinvesting profits in marketing can help you acquire new customers.
For example, maybe you operate a lifestyle clothing brand. Your business is bringing in substantial profits but you think there’s still a lot of room for growth. You could look into influencer marketing, a broad category of marketing that focuses on highlighting your brand through influencers, meaning individuals with large followings on social media and other community based platforms. When an influencer’s followers see this person using your product, they may want to use it, too.
Other options include paid ads through social media sites like Facebook and Instagram, as well as Google Ads. These ad campaigns allow your business to target specific demographics and keywords, which enables your business to effectively reach groups who would be the most likely to enjoy your product. The downside of this is that paid advertising campaigns can be very difficult to operate effectively. As a result, your business may want to look into contracting a marketing specialist in order to get the best return on investment possible.
Hiring new employees, specifically additional employees, is an important aspect of growing a small business. After a while, as a business grows, it can become too demanding for the business owner and the current number of employees to sustain the company and keep it growing. In fact, it can start to hinder growth if everyone is overwhelmed and you have to start cutting corners.
Thus, if your business is growing and your profits are sustainable, you should consider hiring a new employee.
Just remember, hiring a new employee involves a number of different costs besides simply their base salary or hourly wage, so make sure you understand the full weight of the financial liability your business is shouldering whenever it hires a new employee.
Search engine optimization (SEO) is the process of optimizing your website to achieve a higher rank and higher visibility on search engines, particularly Google. Tailoring your content to keywords — certain words and phrases that receive a high volume of search inquiries each month — gets you seen on Google. This helps your business grow through organic traffic, which is essentially any traffic that finds your site on its own (without clicking on an ad or other form of marketing).
Even more so than marketing campaigns, search engine optimization is a difficult process that requires keyword research, as well as an understanding of how search engines index sites and how internet traffic operates. As such, you might consider reinvesting profits in a part-time SEO consultant.
However, if you are confident you’ll be able to do enough research to gain a foundational understanding of SEO, doing your own SEO work wouldn’t cost your business anything! So, that is another route to consider.
Cash flow is an extremely important component of any business, large or small. Too often, otherwise healthy and profitable small businesses succumb to cash flow issues by either spending money too fast or by waiting for customers to pay their invoices.
While there are a number of ways to shore up cash flow, including using merchant cash advances, obtaining SBA loans, or establishing an ongoing line of credit, putting some of your business’s net profits aside to save for a rainy day is one of the best ways to ensure your business has cash on hand if need be.
Remember, cash cannot always be obtained quickly and easily, and cash flow is a real problem for American small businesses all throughout the United States. It’s important to plan for monthly cash flow and make arrangements accordingly.
Investing in employee training can be a great way to improve the customer experience your business offers.
For example, if you operate an online e-commerce website, odds are you will have a customer service team that handles orders, returns, exchanges, complaints, and more. Consider the following situation. You’ve been observing your customer service employees lately, and you’ve noticed that they haven’t been addressing customer issues with the aim of providing a pleasant and positive customer experience. A possible solution could be sending them to a customer service seminar, or bringing in a professional consultant, so that they can learn more about strategies and tactics for dealing with customers in a way that achieves results desirable for both the customer and the business.
Remember, building a loyal customer base is an essential part of building a small business, and just one poor customer service experience can lead a customer to refuse to return to your business for products or services in the future. It can also lead to your business receiving poor reviews on sites like Yelp, which can discourage potential customers from even giving your business a chance.
As always, proper and adequate employee training is a must for small businesses, and investing in improved or continued training for employees is always a route to consider for reinvesting profits.
Paying off debt is never a bad idea for any small business given the proper circumstances. So, what are the proper circumstances? Paying off outstanding debt is only a good idea if it is going to save your business money in the long term. For example, loans that have minimal early exit penalties or no early exit penalties are a great outlet for profits. If you can pay off your debt now to minimize the total interest you pay overall on the loan, that’s great! But first you need to determine whether you should pay off a loan early.
Before paying off debt, make sure to consider the other options and what kind of returns different investments may yield. For example, you may be able to save 2% in interest by paying off a $100,000 loan early. But is that $2,000 actually worth it if you have to pay a $35,000 lump sum to save it? That $35,000 could be put toward something else, such as marketing and business equipment, with a much better return on investment for your business.
Reinvesting business profits in stocks and bonds is always a consideration. Index funds and mutual funds can provide steady returns on your money that exceed savings account returns. Plus, the diversification aspect of index funds and mutual funds can help shield your business from the risks of buying individual stocks and bonds.
In fact, the annualized return for the S&P 500 index from 1957 to 2018 is roughly 8%, a far better return than one would get by storing their money in a savings account. In order to take advantage of these returns, you can invest in one of the scores of S&P 500 index funds on the market, which are designed to mirror the S&P 500 index.
Try to avoid taking big risks though. The biggest risks are typically what lead to the biggest returns, but they are also what lead to the biggest losses. You wouldn’t want to jeopardize your business’s well-being and future sustainability.
Another downside to consider is that any funds you place in the stock market should not be funds you plan on needing to be able to access in a short time period. The cyclical nature of the stock market, with boom and bust cycles, makes it so that you should be prepared to sit on your investments for a long time in case the market does experience an extended bust cycle.
Additionally, you should try to limit the funds you invest in the stock market to excess profits for which you have no other place at the moment. Remember, while funds in the stock market, if invested properly, will be earning your business money, they will be doing little in the way of growing or expanding your business through avenues like customer acquisition, retail space renovations, customer training, etc. In order to improve these, you will need to invest your profits directly into these avenues.
If you decide to go the route of stock and bond investing with some of your small business’s profits, consider using a financial advisor. They will be able to help you invest your money in a safe, but still profitable, way.
Seeing profits rise is always an exciting time for small businesses, but choosing what to do with these funds can be stressful at times. The important thing is to keep your investments focused on the long term goals of your business. The best way to do this is to have a strong, foundational business plan and model from the get-go. This way, you know where you are headed at all times and can leverage your investments to achieve your end goals. Don’t forget that every extra dollar you reinvest can make a difference. You don’t always have to embark on massive reinvestment plans to achieve meaningful growth for your business. Something as small as putting aside an extra $500 to shore up your cash flow can make a difference in the future. With the proper planning and execution, you can make the aspirations you have for your small business a reality.