When your business starts turning a healthy profit, it’s time to start thinking about reinvesting. However, before business owners start channelling money back into their venture, they need to decide how much to put aside. This guide helps business owners to decide what percentage of their profits to reinvest. First, we outline why reinvestment is an important practice for small businesses. Then, we address some popular reinvestment models and note some important factors to consider. We wrap things up by exploring how Kriya could support your business’s reinvestment plans and answering some frequently asked questions.
Turning a decent profit is exciting—especially for new businesses. But every savvy entrepreneur knows that after you've covered your basic expenses, it's wise to reinvest into your venture. Not only will this encourage the growth of your business in the long term, but it can improve the speed and quality of your work. However, before business owners figure out which areas to invest in, they need to decide on a figure. Unless you have been trained in finance or accounting, you likely have no idea where to start.
The truth is, there is no rule when it comes to reinvesting in your small-to-medium-sized enterprise's (SME's) future. While some investment methods work well for some businesses, they may not suit others. Despite there being no one-size-fits-all solution, some concepts are out there that can help. So, to help your business decipher how much money to invest in its future, this guide outlines some important things to consider when agreeing on that all-important percentage.
WHY IS IT IMPORTANT TO REINVEST?
As the saying goes, "you have to spend money to make money". This is the case when it comes to reinvesting in your business. While you have the right to enjoy some of your hard-earned profits, investing part of them back into your products or services is the best way to build momentum. This is especially true for new enterprises struggling to attract a loyal customer base and businesses dealing with fluctuating demand.
In addition to securing your business's long-term stability and success, investing in your venture is a good way to stay out of debt. When it comes to financing small businesses, debt and equity funding are the two of the most common options to choose from. Reinvesting is a form of equity finance; it allows you to change your business without taking on any debt. In a climate where one-third of UK small businesses are in a significant amount of debt, this is one of the biggest assets your venture can have.
HOW MUCH SHOULD MY BUSINESS REINVEST?
Now we've addressed why reinvestment is so important; it's time to answer the golden question: how much your business should reinvest.
Answering this question is never straightforward. Financial experts and entrepreneurs are yet to reach a consensus on an appropriate figure. Some models, like Michalowicz's profit-first model, claim that business owners should set a rigid monthly budget for their profit after they've accounted for expenses like salaries, suppliers and taxes. However, while this method allows executives to set aside a consistent amount of profit, it limits flexibility and may discourage further growth down the line.
Other businesses follow the 50-30-20 model. Adopted from the 50-30-30 model for personal finance, this framework has been adapted to fit the needs of businesses. It recommends that business owners allocate 50% of their profits to paying themselves, 30% to taxes, and 20% for reinvesting in the business. This model gives business owners a reasonable amount of capital to enjoy, prepares them for future tax surprises and still accounts for reinvestment. Despite this, such a rigid financial model is not appropriate for many businesses.
Finally, others recommend that business owners reinvest at least 50% of their profits, claiming that limiting your earnings initially will make your future rewards huge. While this disciplined approach is indeed likely to favour long-term growth, reinvesting such a large amount is largely unsustainable, especially for businesses with lower turnovers.
All of these models have merit. However, there truly is no magical formula to follow regarding reinvestment. Ultimately, each business owner should base their figure on the unique circumstances of their enterprise. To help you work this out, we list three factors to consider when deciding how much to reinvest.
SOME IMPORTANT THINGS TO CONSIDER
1. What are my business’s core needs?
The first thing you should think about when calculating a reinvestment percentage is your primary business needs. Business needs are the gaps between the company's current state and its goals. They can include any area of your business that needs to be worked on to maintain growth. By identifying these core needs, you can recognise which areas of your business are in greater need of investment.
Below we list some examples of common business needs that could be relevant:
- Employee training Are your staff equipped with the skills they need for your business to excel? Would they benefit from in-person or online training programmes if there is room for improvement on this front?
- Recruitment Has your business reached capacity when it comes to taking on new work? If so, should you onboard more staff to bring more value to your team?
- Digital equipment Is your company already digitally optimised? If not, would your business benefit from investments in digital tools like cloud computing, data analytics or artificial intelligence?
- Office equipment If your business has a physical office space, is its current equipment satisfactory? If not, should you put money aside to update or purchase new office equipment like furniture, stationery or hardware?
- Office Space Are the needs of your business outgrowing the size of your office? Would you gain from investing in a larger space or adding another location?
- Marketing Is your marketing strategy effective? Would it be worth exploring new marketing methods like social media, content, or search engine marketing?
2. Product and service development
Are the products or services you provide of the highest quality possible? If you redeveloped your existing profit makers or brought new products or services to the market, could this improve your return on investment? What are my business’s long-term goals? Every venture has its own vision of where it'll be in the future, and business objectives help them achieve these goals. The amount you funnel back into your business massively affects your chances of meeting these goals. Therefore, it's crucial to review the objectives of your business when arriving at a figure.
When reflecting on your goals, there are several things to consider. You should think about why you started your business if you're looking to expand, and, if so, by how much. You should also give thought to what drives you. Is it profit? Or is it the product? Finally, you should consider whether you're looking to keep your business or potentially sell it further down the line. By touching base and reviewing plans, you will gain a much clearer indication of how much you should reinvest.
If you haven’t developed a set of clear business objectives, now is the time to start. Not only do they provide you with a clearer direction and give you a way to measure progress, but they also are an excellent way to motivate you and your team. When establishing your business’s goals, they need to be SMART: specific, measurable, achievable, realistic and time-orientated. By using this SMART model, your business will have a much greater chance of hitting its targets.
3. How much revenue is my business generating?
While your business's needs and goals are important, the amount your business can reinvest will be largely determined by its financial circumstances. Therefore, another important thing to consider when deciding how much to reinvest in your business's income.
Your net income is simply how much money your business has leftover at the end of a given time. Simply deduct your business expenses from your total profits to calculate your net income. While taking note of this figure is important, you should also consider whether this amount grows or shrinks each year and if it remains relatively consistent throughout the seasons or fluctuates.
Aside from measuring your business's revenue, you should also assess your current cash flow and your cash flow forecast. To measure your cash flow, add up cash from investing, financing, and operating activities. For your cash flow forecast, add the cash you have at the start of a given period, with your projected inflows, before misusing projected outflows. By reviewing these figures, you can understand how much cash your business has to spare at any given time.
Once you have these figures, you will understand your financial boundaries more clearly and have a greater idea about how much money your business can reinvest.
How much do I want to be paid?
Another vital thing to consider is how much you, the business owner, want to take home. While this may be one of the simplest elements, in theory, it can also be one of the hardest. This is because while deciding your own salary might sound like a dream come true, it comes with many complications.
For instance, business owners need to consider if they want to get paid based on what they think they're worth or what they think they need. If you pay yourself what you're worth, you can live comfortably and have funds to spare for personal savings or investments.
On the contrary, if you pay yourself based on your needs, you will only have enough to cover basic personal expenses like rent, utilities, food etc. If a business isn't bringing in profits, some owners may even decide against a salary. However, while it may seem like good business sense to limit your salary or scrap it altogether, compensating yourself poorly could disincentivise you or make you more vulnerable to burnout.
To arrive at a reasonable figure, we recommend that you research what other people in your position are receiving and use that figure as a baseline. This amount will likely vary depending on the size of your business, the industry and your seniority. You can then adjust this amount accordingly, depending on your personal and business requirements.
LOOK AFTER YOUR COMPANY’S FINANCES WITH KRIYA
The benefits of reinvesting are obvious. Not only can it increase the value of your business and secure its long-term growth—but it can also offer business owners peace of mind. For businesses experiencing steady growth, funnelling part of their profits back into their venture is simply a no brainer. However, even if your business doesn't have surplus capital, it doesn't mean you can't invest in the future of your venture.
Kriya offers a range of cashflow solutions for SMEs that struggle to secure funding from traditional means. Whether you're looking for temporary or long-term financing, chances are we have you covered. Suppose delayed invoice payments prevent you from investing in your company's growth.
In that case, our invoice finance option can help you quickly and easily retrieve money that is owed to you quickly and easily. If your business is still recovering from Covid-19, you may be eligible for the Recovery Loan Scheme. This loan scheme offers business funding from £50,000 to £350,000 and requires interest-only payments for the first six months.
Working similarly to a business overdraft, this method allows you to request and repay money whenever it suits your business. For eligibility criteria and more information on our cash flow solutions, visit Kriya to find out more.
FREQUENTLY ASKED QUESTIONS (FAQS)
What does it mean to reinvest in my business?
Business reinvestment refers to funnelling a certain amount of profits back into your business. It's an effective way to increase the value of your business and invest in its future growth. The amount a business owner will decide to invest depends on several factors, including their business's core needs, their long term goals, the amount of revenue they are generating and how much take-home pay is agreed upon.
Why is it important for small businesses to reinvest?
Business owners need to reinvest in their venture for many reasons. Reinvesting can allow businesses to develop or expand their existing premises, improve the quality of their product or service, and strengthen or grow their team. By doing so, employee satisfaction can be improved, more revenue streams can be created, and the business's long-term growth can be supported.
What areas of your business should you reinvest in?
If you've decided to reinvest back into your business, there's no right or wrong way to spend the money. Where you choose to invest should be based on your business's circumstances and needs. However, as a rough guideline, some popular areas to invest in include employee training, recruitment, digital or office equipment, office space, marketing or product and service development.
How much should I reinvest in my business?
How much you decide to reinvest is completely up to you. What may work for some businesses may not work for others. However, before you decide on a figure, it's wise to consider a few things. For instance, factor in core needs, long term goals, revenue, and how much money they want to take home. This should help you decide on an appropriate percentage for your business.
What are the disadvantages and advantages of reinvesting profits?
Before reinvesting in your business, consider the potential advantages and drawbacks. By retaining a certain amount of profit, your business can improve the product, attract more customers and yield more profits in the long run. On the contrary, there’s a chance business could struggle in the short term if you don’t have enough capital to cover basic expenses.
How do I establish my businesses long term goals?
If you haven’t yet developed a set of clear business objectives, now is the time to start. Not only do they provide you with a clearer direction and give you a way to measure progress, but they also are an excellent way to motivate you and your team. When establishing your business’s goals, make sure they are SMART: specific, measurable, achievable, realistic and time-orientated.
As a business owner, how do I decide how much to pay myself?
To arrive at a reasonable figure, we recommend researching what people in your position are receiving and use that figure as a baseline. This amount will likely vary depending on the size of your business, the industry and seniority. You can then adjust this amount accordingly, depending on your personal and business requirements.
