Cost of living - Should I be taking earnings out or reinvesting in my business?

Cost of living: Should I be taking earnings out or reinvesting in my business?

Amidst the current UK economic situation, owner-managers are facing hard decisions at every turn. From supply chain issues to hiring, resources within companies are at a premium, none more so than cash. This leaves business owners with a thorny question when they themselves may be struggling: should they extract earnings from their business for personal use, or reinvest them to fuel further growth?

With credit becoming tighter and unexpected costs always looming, the right level of cash-in-business versus extracted profit remains a moving target. The right strategy is also highly dependent on the personal financial goals of the business owner and the stage of business they are in. Here, Haines Watts Group Managing Partner Matt Bracher digs into how owner-managers can get the most out of their cash and balance their business and personal needs.

Current Economic Situation

Since March 2020, the onset of the COVID-19 pandemic has introduced a high level of uncertainty into the business market, which has since failed to deliver the stability that business owners crave. This period has been characterised by an economic malaise, continuous supply chain disruptions and material shortages, leading to production issues across various sectors.

Volatility in political and commercial events has  been reflected in the financial markets, exacerbated by policy decisions, leading to  fluctuations in interest rates and steep costs for borrowers. For owners who rely on external funding or credit to cover shortfalls in revenue and cash flow, many have found previous sources of capital unavailable.

All this combines to make cash a more precious commodity, adding pressure to the core financial processes in businesses, from credit control to cash flow management, and limiting the scope of some owners and directors to withdraw money at will. However, the precise impact of these shifts is highly dependent on the stage and goals of each business.

Early-stage businesses

For younger businesses, a solid foundation is essential for navigating the initial stages of growth and development. These early years are critical for establishing financial stability and setting the groundwork for future expansion, which requires a reliable balance sheet.

The key needs of younger businesses usually revolve around managing limited resources, maximising tax efficiency, and planning for the long term – in practice, this usually means prioritising the growth of assets and capital within the business.

• Maximise tax efficiency: Leveraging personal allowances, available tax band and reliefs to minimise tax liability and maximise net income. This includes R&D tax credits and pension allowances, where early planning can provide tax advantages and secure financial futures.
• Building stable foundations: The balancing act for early-stage businesses requires spending, but in the right way. Reinvesting profits back into the business can fuel growth in products, team or footprint, while a focus on solid financial health can improve creditworthiness and provide a buffer against future risk.

Mature Businesses

For mid-life businesses, where revenue in and costs out have reached a stable balance, strategic financial management becomes centred around optimising profit extraction for personal benefit or reinvestment in a way that aligns with long-term wealth planning.

This stage demands a balanced approach to extraction and investment, considering both the personal financial goals of the business owner and the operational needs of the business. However, the advantage when compared to early-stage businesses is that the mature companies have often built up more credit and flexibility with suppliers and customers, with owners able to provide cash injections back into the business as loans, if needed, to cover unforeseen expenses or investment opportunities.

• De-risking the business: Regular profit extraction in the mature stage can serve to de-risk the business by removing liable assets and capital from the company.
• How to extract: At later stages, income from your business may well be at a level high enough to put you into a higher tax bracket, requiring more nuanced balancing of salary and dividends, together with alternative cash extraction methods and consideration of the advantages of more complex ownership and profit sharing structures.

Late-stage businesses

Approaching the exit stage of a business, whether through sale, succession, or keeping it in the family, presents its own set of considerations regarding profit extraction. The cash strategy will depend on your plan for the business – in the event of a sale based on a multiple of revenue, maximising maintainable profit within the business can fetch you the best price. However, in the event of a management or family succession, it may be preferable to separate out some assets to achieve a lower, more attainable price.

• Tax advantages: Keeping cash within the business until the point of sale may, in certain circumstances, enable extraction at preferential capital gains tax rates rather than income tax rates, offering a more favourable tax outcome.
• Structuring for extraction: Business disposals may be simplified by separating the business into discrete parts that can be more attractive to the market, giving owners a chance to extract value on a targeted basis.

Managing Capital with Haines Watts

At Haines Watts, all work with clients starts on a basis of a shared understanding of what it means to be a business owner.

As owners ourselves, we approach advice with a spirit of collaboration, having faced similar challenges with both clients and within our own businesses. Our goal is to provide empathetic and strategic advice tailored to the specific needs of each business. Whether it’s going over monthly accounts to spot red flags for your cashflow or preparing specific tax strategies to maximise available capital in the year ahead, we’re your partners for whatever the market throws at you.

If you want to find out how tailored advice from an experienced Haines Watts adviser can help your business keep moving forward, get in touch with one of our team today.