Last week I challenged you to prepare the information you need to go out and get financing, whether you need it or not. The goal of business is to generate a profit. Let’s assume you have accomplished that. Now what?What should you be doing with the cash? Seems like a dumb question right? You would be surprised at how many business owners don’t know how to use their profits strategically.
Your challenge this week is to prioritize your various uses of cash so you build value for your company, what I would refer to as self-funded growth.
Self-funded growth refers to generating all of your needed funding from internal operations. This ideally means that you can fund all current operations, build a cash reserve and still have cash left over for reinvestment in the company.
The reinvestment should be planned and implemented in alignment with the company goals. Here are some priorities to consider:
Pay Taxes – The first priority you must address is taxes. You should generally set aside 40% of your taxable profits as you earn them on whatever basis your return is prepared under. Implementing a regular system of either paying your company’s taxes as income is earned or, if you are not yet required to pay the taxes, setting aside the tax payment money in a safe account, will help you know what portion of the money made actually belongs to you.
Pay Down Debt – After taxes, your next priority should be to pay down all debt. For starting businesses, consider setting up term notes over using lines of credit. Eliminate the temptation of drawing on your line to solve cash flow shortages that in reality postpone needed changes in your business or in your business model itself. Mature businesses can use term notes for equipment for purchases where the note covers the term of the asset’s useful life. But this is still second-best to having no debt.
Retain Money For Working Capital – A good “spare cash” target for a business is 2 to 3 months of operating expenses after all other debt has been paid. You can adjust this number up to 6 months if your business does not have significant receivables or equipment that can be leveraged in a crisis. You would also add to this amount any major equipment purchases or acquisition plans.
Pay Dividends to Owners – After the first three priorities have been addressed, it is finally your turn. This is the point at which the owner(s) can pull cash out or sell or well at that point your options are many. The company is now a profitable enterprise that has paid all its taxes, is debt-free, and has anywhere from 2 to 6 months operating expenses in the bank. This is a business that somebody would buy. But you also have a business that is spinning off a return to its investors (you!), which means that you have a lot of choices.
Knowing your cash priorities and using your cash to 1) pay taxes, 2) pay down debt,3) cover working capital, and 4) pay dividends to the owner creates value for your company and gives you options that can support your passions in life and what you want to do next. Isn’t that fun to think about?
To Your Success,
The Rector Group
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