Managing your cash surplus is an important part of running your business as it can fund and spur growth. While it is an advantage, it requires careful planning, so read on to find out.
Cash surplus is a situation where the cash inflows exceeds the cash outflows. Once you have built up a cash surplus within your company, the very first thing you need to do is determine how much of your surplus is true free cash. Then, the next step is to consider how to best use your cash surplus.
At Tax Agility, we are London’s small business accountants helping SMEs managing their accounts and meeting financial obligations. We understand that many company directors want to build a strong cash surplus so they can adapt to market changes. With this in mind, we aim to discuss five effective ways to manage it.
1. Pay down debt
When the cash reserve is strong, the first thing most business owners tend to do is to pay down debt, particularly if you are serving a high-interest loan and you know that returns on short-term investment are not likely to be greater than the debt you have.
2. Create an investment portfolio
Cash surplus presents an investment opportunity, which will hopefully yield a greater return. There are several investment opportunities including but not limited to:
- Invest in growing your company – this can range from buying a new vehicle to assist your fulfilment process and make it more efficient, to hiring another sales person to generate more business.
- Invest in property – purchasing an office building may help to reduce your rent and at the same time, increase your asset portfolio. Alternatively, you can rent them out to earn income.
- Invest in stocks, shares, bonds or even other companies – the motivation here is to get good returns, thereby strengthening your cash reserve even further.
Before entering any of these investment options, you are advised to do your due diligence because investment is inherently risky. Moreover, careful consideration and planning should be given when assessing how much cash your business can invest.
3. Place it into high interest accounts and bonds
As investment is inherently risky, a risk-adverse approach is to put your cash surplus into high-interest accounts and bonds.
These high-interest accounts and bonds will lock up your cash for a decided period of time, meaning your cash is in a safe place while it earns you interest. However, the downside is that you will not be able to access your cash before the agreed term ends, unless you pay a steep withdrawal penalty. In other words, your funds will not be available (without penalty) in the event of an emergency.
Other things to consider are that bond prices can fluctuate and credit risk. Credit risk means the bond issuers may be unable to pay and default on their interest and principal repayment.
4. Distribute as dividends
In order to be tax efficient, company directors often choose to pay themselves a low salary and use dividends to make up the rest of their income. The reasons are:
- Dividends have a lower tax rate than salaries.
- Dividends are not subject to National Insurance contributions.
- You will enjoy a £2,000 dividend allowance.
So declaring all, or part, of your cash surplus as cash dividends is a simple and tax-efficient way to remove profits from your company and add it to your take-home pay.
However, if your total income (including your salary, any interest payments, and your dividends) exceeds the high rate threshold, you will have to pay additional tax on your dividends.
5. Fund a pension pot
Retirement planning is essential nowadays, as pension provides an income which will help to maintain a good standard of living when you retire.
Using cash surplus to fund a pension pot is an efficient way of moving cash away from your company, as contributions made during an accounting year will receive full corporation tax relief (certain restrictions will apply), and you will not be liable to pay National Insurance Contributions (NICs) on them. The downside, of course, is you won’t be able to access these funds until you retire.
Talk to Tax Agility about your cash surplus
At Tax Agility, we pride ourselves in helping small businesses across London with their accounting and tax matters. We also work with aspired business owners who want to grow their company sustainably. If you are thinking of using your cash surplus to invest and spur growth, our trusted independent business advisors are here to help and discuss your options objectively.
Give us a today on 020 8108 0090 or get in touch with us via our contact page to arrange a complimentary, no obligation meeting.
This article was updated on 18/09/19.
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This post is intended to provide information of general interest about current business/ accounting issues. It should not replace professional advice tailored to your specific circumstances.