When your small business starts turning a profit, what do you do? 

This is a good problem to have! Imagine your business as a fruit-bearing tree – it gets reset every year. The tree needs the support of a strong trunk (the balance sheet) and one that gets thicker with each passing year. Also, preferably lots of water (cash flow) to produce large and juicy fruit which is the measure of the annual orchard’s yield (though the income statement).

In a company’s balance sheet under the shareholder’s equity section, you will find a line item called retained earnings (or less commonly called accumulated earnings). REs are after-tax profits that are built up over the years held within a corporation. They represent the portion of net income on a company’s income statement that is not paid out as dividends. Rather, these earnings are retained. In case you’re wondering, it is definitely adding esteem to the fair market value of your corporation.

Similar to a tree, a business produces an annual yield and at the end of each year, net earnings are added to Retained Earnings on the balance sheet. Now, how can a company look to the future when deciding where to allocate their new cash inflows? Reinvesting business profits back into the company is the best way to ensure longevity. In view of this fact, we’ve provided you with a guide on what we suggest to do with your Retained Earnings.

Proactive Ways to Use Retained Earnings

Studies show retained earnings are more precious to a business owner than any other asset or portfolio an individual has and therefore, states the reason why they are usually held in GIC’s or other fixed income type assets for safe keeping. Some alternative uses for this money may be better served by one of the following options:

#1. Take the Money As A Dividend To Shareholders (Yes, they would need to pay taxes on that income!) – Once a company starts making money, then it’s retained earnings start to rise. After the company has satisfied earlier losses, a positive balance in its retained earnings will allow it to pay dividends if it chooses. If a company’s shareholders agree that they could make a better, safer, or even stronger return on their investment dollars outside of the company than within it, then it may make sense to take the dividend and invest elsewhere. 

#2. Grow Your Business Through Acquisitions – This has become a popular business strategy for companies looking to expand into new markets, gain a competitive edge, or acquire new technologies and skillsets. This includes commercial or industrial real estate property too, namely renting vs ownership. Whether the acquisition is a share buyout or just an asset/equipment purchase, and working with qualified financial professionals, this can be a viable medium-term growth strategy.

#3. Invest in Your Team Members –  Investing in human capital will ensure organic long-term growth for your business. Further, reinvesting some of your business’s net profits to provide continuing education and training for your employees eventually leads to offering promotions and benefits packages. This way, your employees will be more motivated to stay. Experts say employees usually care about benefits before even salaries or raises are mentioned!

#4. Invest in A Participating Life Insurance Policy – That the company owns facilitating a buy/sell agreement or an Estate Plan. Life insurance is a benefit that is used to preserve the value of a shareholders estate, provide financially for dependants or a surviving spouse/shareholder, and ensure money is available to pay for any taxes, fees, or other outstanding debts upon death.

Did you hear?  Insurance is the ‘new’ fixed asset class. Although the natural inclination is to keep retained earnings safe in an investment of a fixed asset class nature, a Corporate Owned Life Insurance policy with Cash Values, namely a Participating Policy, may just be the tax-sheltered solution for these corporate assets. Safety comes first!

#5. A Combination Of These – Depending on the rate of return (ROR) of each point.

I know these methods might seem intimidating, or even confusing at first. It’s important to note that I’m here to make things less of a hassle. In Part 1 of this article, we’ve talked about (a) what retained earnings are (b) why it’s important to focus on this column of your balance sheet and (c) proactive ways to use these retained earnings. Now, you might be thinking “Okay Gino, but how do I choose between all of these options?” Well, that’s what we will be talking about in Part 2 – how do you decide what to do with these retained earnings?

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