Are You Investing Enough of Your Profits Back into Your Business?

You’ve probably heard the old adage “You gotta spend money to make money.” And while you don’t need to put ALL your profits back into your business, reinvesting your earnings can bring you closer to your big goals.

You’ve probably heard the old adage “You gotta spend money to make money.” And while you don’t need to put ALL your profits back into your business, reinvesting your earnings can bring you closer to your big goals.

Just like any decision for your small business finances, deciding to reinvest profits should be done with intention. Throwing random money at your business doesn’t guarantee success. And hoarding money or being too afraid to spend it can stagnate your business growth. Deciding how much to reinvest in your own business is a balance between taking some risk and maintaining a level of personal financial security.

Here are five questions to help you decide how much to reinvest in your business:

1. What do you want to invest in?

Before getting into the numbers, identify what part of your business you want to invest in. Take a step back and reflect on your long-term goals for the next one to three years.

How do you see your business growing during that time? Will you:

• Increase your revenue?

• Grow your team with new employees?

• Launch a new product or service?

• Build your brand assets?

• Step up your digital marketing efforts with search engine optimization (SEO) and social media, or expand your overall marketing strategy to expand your customer base?

• Purchase tools, machinery, or new technology that increases the efficiency of your work?

• Outsource areas of your work?

• Learn or improve a skill or trade? Provide employee training?

Get clear about your ideal future for your business and what changes will need to happen to get you there.

Next, think about the challenges you’re currently facing as a business owner. What’s holding you back from meeting your goals? Is it:

• Lack of administrative support?

• Lack of visibility?

• Not enough clients?

• Too many clients and not enough time to focus on other areas of your business?

• A bottleneck in your production process?

Now, with a clear idea of your business goals and challenges, identify the potential investments you could make in your business. Investments can range from small purchases like software to larger expenditures like equipment and staff.

Don’t worry too much right now about what’s feasible. Instead, make a list of everything you would like to invest in, the estimated cost, and whether it’s a one-time or recurring expense.

2. What’s the timeline for your reinvestment?

For each item on your investment list, prioritize them in order of urgency. Remember, sometimes our investments build off of each other. As a small business owner, you may need to invest in one item before you can invest in another. Put your potential investments in an order that makes sense for your business needs.

Also consider the potential return on investment of each of your options—and how quickly you will see those results. If you don’t have the funds immediately available for purchases with a slower ROI, then you can invest in expenses with a quick ROI first. For example, if Facebook Ads for a product and SEO for your website are both on your investment list, you may want to invest in the Facebook Ads first so you can funnel the additional revenue into SEO.   

Next, come up with a tentative timeline for your investments. At what point would you, ideally, like to invest in the item? Is it six months from now? Two years from now? Five years from now? Knowing when you’d like these purchases to happen will help you allocate your profits later.

3. What’s your available profit?

Your business profit is the amount you have to reinvest in your business. This is the money that’s left over after you subtract your business expenses from your total revenue. Technically, you’re already reinvesting in your business by paying for ongoing business expenses. But where most people get stuck with reinvesting is when they have a surplus of money or profit.

Remember, not all of your profit is available for reinvestment. You also use your profit to pay off business debt, pay your taxes, and pay yourself. Before we can calculate your available profit, we need to know your average monthly profit.

The easiest way to figure out your monthly profit is to run a Profit & Loss report in your bookkeeping program or ask your bookkeeper to prepare this report for you. If you don’t have a bookkeeping program, you can calculate your profit by subtracting business expenses from your total revenue.

Now we’ll figure out how much profit is available to reinvest in your business. First, subtract any long-term liability payments that you’re making.

Long-term liabilities are business loans or credit card balances that you’re paying off over time. Since you are required to pay them, we need to be sure you aren’t reinvesting the money that you need for payments!

Then make sure you’ve allocated a portion of your profits for taxes. Most people save 25 to 30% of their profits for taxes, although this number could change based on how much you reinvest in your business. For example, if you profit $10,000, then your potential tax payments would be $3,000. But, if you decide to invest $2,000 of your $10,000 profit into a piece of machinery, then your profit is $8,000, and your tax payment is $2,400.

What’s left is your available profit! Here’s an example of how this looks:

4. What’s the bare minimum that you need to get paid?

Now that you know your available profit, it’s time to decide what the bare minimum is that you need to get paid. This is the lowest number you could receive from your business and still be financially stable in your personal life.

For some people, this number could be very low or even zero. For others, it could be much higher. It depends on your personal financial situation.

Here’s an example:

If the bare minimum number is bumming you out, don’t worry. In the next step, you’ll make decisions about how much profit you’re going to allocate to yourself and your business.

5. How will you allocate your profit?

Now it’s time to figure out what to do with your allocatable profit. Will you reinvest it or pay yourself more? This is the burning question for most business owners.

Return to your investment list. What investments would you like to make in the next six to 12 months? For recurring investments, how much will they add to your total monthly business expenses?

For one-time investments, how much would you need to save each month to afford the purchase based on your timeline? For example, if you want to spend $3,000 on new tools in the next six months, then you will need to save $500 a month.

Here’s an example of an investment list:

You can approach allocating your profit in one of two ways:

Option 1

First, you can simply add up everything on your list and allocate the total amount toward reinvestment. The remainder goes toward your owner's pay.

In the example above, this person would put $1,415 of their $2,750 allocatable profit toward reinvesting in their business and $1,335 towards increasing their owner pay.

If what you want to reinvest is more than your allocatable profit, then you’ll need to adjust your timelines or reprioritize your investments.

This method works well for businesses with consistent monthly profits that prefer to reinvest in their business gradually over time.

Option 2

The second way is to put a fixed percentage of your monthly allocatable profits toward reinvestment. For example, if the person in our example wanted to invest 70% of their allocatable profits back into their business, that would be $1,925. This scenario accelerates the reinvestment timeline but also lowers their owner's pay.

This method works well for businesses with inconsistent profits every month and who prefer to use surges in their cash flow to accelerate reinvestments.

In either scenario, the choice you make depends on your unique financial needs. People throw around all sorts of percentages for how much you should reinvest in your business. Rather than relying on blanket percentages, make your reinvestment decisions based on your personal financial landscape.

When you strike a balance between reinvesting in your business and taking care of yourself as an owner, you’ll receive more joy from being an entrepreneur while also slaying it on the business front.

FAQs

When should a business reinvest profits versus distribute them?

It’s a good idea to reinvest your business profits back into your business when you see the potential for a strong ROI—and when it improves your overall financial health. That might be a promising partnership, a big project, or an expansion of your business space. If the investment could yield even more profits than you put in, it’s worth it. If, on the other hand, you’re tapped out of growth opportunities, distributing your profits to individual shareholders can be a good way to go.  

What are the risks of reinvesting profits back into a business?

When you reinvest your profits back into your business, you run the risk of encountering a cash shortage or losing a major chunk of capital if your investment doesn’t pay off. You’re also risking your own personal financial security by putting all your profits back into your operation. 

How do tax considerations affect decisions to reinvest profits?

Reinvesting your business profits doesn’t exempt you from paying taxes. You still need to make sure you have enough money set aside to cover your regular payments, but certain investments can actually come with tax advantages. When you make big purchases like equipment or machinery, for example, you can usually write those off. 

How much profit should a business reinvest versus keep as cash reserves?

How much profit you reinvest versus save depends on your business’s starting point and growth goals. Businesses that are just getting off the ground—or entering a big growth period as a startup—might allocate more profit for reinvestment than for padding their cash reserves. In general, though, a good rule of thumb is to build a cash reserve large enough to cover three to six months of operating expenses. Once you have that, you can reinvest anywhere from 20-50% of your profits back into your business. 

What are the best areas to reinvest profits for long-term growth?

If you want to set your business up for long-term growth, focus on reinvesting your company’s profits in key areas: your employees, your product, and your marketing. That might mean investing in new hires or expanding your employee benefits to raise retention rates, upgrading your technology or services, or putting more money toward diversified marketing tactics so you reach more potential customers.