One constant question for entrepreneurs is how much of the profits should be invested in the company and how much could be taken out as dividends or wages. Investing in a company is a prerequisite for developing a company. However, in order to achieve the goals, there must also be a clear plan and strategy behind investments. And in all this, one should not forget to maintain the financial stability of the company and the financial interests of the business owner.
To find out how much profit to invest in a company, you should start a few steps further.
1. Make a list of what investments your company needs
Before you get to the numbers, you need to find out which areas in your company need investment. To do this, it’s a good idea to put together a business development plan or a wider-scale strategic plan to define the direction your business will move in the coming months and years.
For example, do you want to:
- increase sales revenue
- grow a team
- launch a new product or service
- strengthen the brand
- streamline work processes or reorganize existing work
- develop your skills or expand activities, etc.
Once you have defined the direction, you should next assess what obstacles or challenges are currently preventing you from achieving your goals. Is it, for example, the lack of administrative support, low awareness, small number of customers or, conversely, too many customers, which does not allow you to focus on the strategic management of the company, outdated equipment, etc.
Once you have identified your goals and potential barriers, write down what investments you would need to make to achieve those goals, along with an estimate of the cost and whether it’s a one-time or recurring expense. In some cases, a smaller purchase of software is sufficient to achieve the goals. Otherwise, you will need to make higher expenses such as investing in equipment or hiring staff.
2. Set priorities and time frame
The list of necessary investments is often quite long. It is then useful to prioritize the registered investments, ranking them according to how urgent these are and how fast one or the other investment is producing results. Some investments may require you to make another investment beforehand (for example, you must first purchase a new device in order to hire someone to work with the device).
It is always necessary to add a time dimension to the list of investments. At what point should one or another investment take place? In six months? In two, five years? This makes it easier for you to add an annual or quarterly financial dimension to your investment plan.
3. Calculate the potential profit available
The potential profit available is the maximum amount you can invest in your business. This is the money that will remain with you after you deduct the company’s expenses from the sales revenue. However, you should be aware that not all profits are available for reinvestment. This means that you can also use the profits to pay off the company’s liabilities and debts, as well as to pay to yourself.
Average profit per month
Before you can calculate the maximum possible profit, you need to find out what your company’s average profit is in a month. The easiest way to find the average monthly profit is to extract the income statement from the accounting program or ask the accountant to prepare a corresponding report. If you do not have an accounting program that would issue an income statement, you can also calculate the profit yourself by deducting all expenses related to the company’s operations from the total sales revenue.
To find out how much of the profit is potentially available, also deduct all non-current liabilities such as loans and credit cards from the received outcome, because before you make additional investments, you need to make sure that you do not invest the money you have to use to meet the liabilities.
The minimum amount you need to pay to yourself
Knowing the maximum possible profit available, it is time to decide what is the absolute minimum to pay to yourself. This is the lowest number you should receive from your business to satisfy you financially as an owner.
For some businesses, this number can be very low or even zero. For others, it may be significantly higher. It all depends on your financial situation and whether you are committed to your company on a part-time basis and get paid elsewhere, or if this is your main job.
4. Decide how to distribute profits
Now we come to the most crucial question: how to distribute profits. Invest it in a company or pay more to oneself? How to find the right proportion?
Profit distribution can be approached in two ways:
Option A: add up all required investments for the next month / quarter / year and invest the required amount in the investments. What’s left over from the investment goes to your owner’s fee.
This method works well for companies with the same monthly profit. If the amount needed to invest exceeds the potential return available, you will need to review your investment schedule or rearrange your investment.
Option B: Another option is to channel a certain percentage of the monthly return on investment. Such a solution is suitable for companies which profits are uneven from month to month and which prefer to increase their investments as their profits increase, while reducing them in the months with more modest sales.
It is often desired to know the optimal percentage of profits that could be invested in a company. However, instead of relying on a fixed percentage, the decision to invest in a company should depend on what your company’s goals are and your own financial expectations of the company as an owner.
The amount you can invest in your business from your profits should be in the order of magnitude that you are willing to risk while maintaining financial security. It is clear that simply keeping money in a bank account does not create value for the company, so it is worth investing in profits in any case. However, this cannot be done without a thorough preliminary work and plan, because like any other decision in business, investing profits in a company must be based on the company’s strategic plan and the goals stipulated therein.