What to Do Once Your Business Starts Making Serious Profit!

Congrats, your business is a success!

You have three main options for utilising the profits in your business (or you could choose a combination of all three):

• Reinvest the profits in your business.

• Retain the earnings (either to create a cash buffer or to invest).

• Take a larger salary or additional dividends.

Let's unpack the pros and cons of each!

Reinvest the profits in your business

This strategy involves using profits to strengthen your business. You could:

• Invest in better / more efficient systems,

• Bring on additional staff or equipment, or

• Expand your business into new services, products or areas.

Before you go down this path, it is imperative you complete a cost/benefit analysis and a business case for the use of these profits to determine if the return on investment will be sufficient.   

The way you deploy these funds needs to outperform the opportunity cost of what you could otherwise do with these funds such as paying off business debt or declaring dividends and using those funds to build wealth in your personal name.

Retaining the earnings

You could retain the earnings to:

• Build a cash buffer (usually 3 to 6 months) which can provide protection during downturns or unplanned shocks.

• Invest the funds within your company.

  
  

Your company can invest its surplus profits into assets like:

• High-interest business savings accounts (although be aware, some banks offer a much lower interest rate for business accounts than you can obtain personally)

• Term deposits

• ETFs or shares (although this comes with added tax and risk considerations)

However:

• Investment income earned by a company is taxed at the corporate rate which may (or may not) be higher than other options in your personal name. Additionally, companies do not benefit from the 50% capital gains discount available to individuals or trusts for any investments that generate capital growth such as shares.

• If your business is no longer predominantly a trading business and instead becomes an “investment company”, you may lose access to certain small business CGT concessions down the track.

Take a larger salary or additional dividends

Whilst this option may not necessarily be the most tax effective it is often worthwhile because:

• You may have opted to draw a lower salary in the earlier years of your business, and it could be time to reap the rewards.

• You may need the additional income to meet your personal life goals.

• You may be able to deploy tax effective strategies in your personal name, such as making extra deductible contributions into superannuation.

  
  

You should always consult with an accountant when determining how to withdraw money from your business as you need to be aware of:

• Division 7a loans: If you withdraw money from your company (e.g. for personal use) without taking it as salary, dividend, or a compliant loan, it may be treated as an unfranked dividend — triggering unintended tax consequences.

• Franking Credits: If your company is paying tax at the corporate rate (typically 25% for base rate entities), it builds up franking credits. You can use these credits when paying dividends to shareholders, offsetting their personal tax obligations

Thinking about your business as an asset

As most businesses are valued and sold based on a multiple of profit, the more profitable your business, the more valuable it becomes.

This makes having your business affairs in order, even more important.

If you have business partners, you must have shareholder and buy sell agreements in place to ensure the value of your business assets are protected.

You should also consider maximising the value of your business sale by:

• Removing key person risk in the business: The risk that the value of the business is too inherently tied up in individuals (such as directors) rather than the fundamentals of the business.

• Removing risks within the business, such as systems and processes, legal and compliance, staff turnover and external supplier contract risk.

• Understanding your eligibility for small business capital gains tax concessions.

We work with many successful business owners to help them plan their business and personal financial futures. You can visit our Business Owner hub or book in a free initial chat below:

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General Advice only.