Deciding what to do with the profit

Aug 29
3 min read

Updated: 3 days ago

Introduction

A business has a good year. There is money in the account, and the decision about what to do with it is made informally: some is taken out, some is spent on something that seemed useful, and the rest stays where it is because nobody decided otherwise.

Repeated over several years, that pattern is the strategy, whether or not anybody intended it. A business that reinvests consistently looks entirely different in a decade from one that distributes, and both look different from one that builds reserves. This is one of the few genuinely strategic decisions a small business makes annually, and it is usually made in an afternoon.

1. Deciding what to do with the profit is a strategic choice, not an accounting one

Recognise what is being decided.

Reinvestment buys future capacity, distribution converts business value into personal wealth, and reserves buy resilience. Each is legitimate, they compete with each other, and the balance defines what the business becomes.

2. Establish what the profit actually is first

Before allocating any of it.

Accounting profit is not cash, and tax on it has not yet been paid. Owners who distribute against a profit figure without accounting for the tax liability create a cash problem for the following year.

3. Build a reserve before anything else

The unglamorous priority.

Enough to cover several months of fixed costs, held separately. Businesses without reserves make decisions from a position of weakness during every downturn, and the cost of that exceeds whatever the money would have earned elsewhere.

4. Invest in what removes a constraint

The most productive reinvestment.

Not what is exciting, but whatever is currently limiting the business: capacity, a bottleneck in production, the owner's own time, or a skill you have to buy in expensively. Investment aimed at a genuine constraint returns quickly.

5. Be honest about whether growth is the objective

Not every owner wants a larger business.

An owner who wants a stable, comfortable business should distribute more and reinvest less, and that is a perfectly sound choice. Problems arise when the stated ambition and the allocation of profit point in different directions.

6. Consider reducing debt

Frequently the best risk-adjusted return.

Paying down borrowing reduces fixed costs, removes personal guarantees sooner and increases resilience. It is unexciting and it competes well against most alternative uses of the money.

7. Decide it deliberately and in advance

A policy rather than a reaction.

An agreed split — a proportion reinvested, a proportion distributed, a proportion reserved — removes the annual negotiation and stops the decision being made by whoever needs cash most urgently.

8. Agree it between owners before the year end

Where partnerships come under strain.

Owners with different financial circumstances want different answers, and this is one of the most common flashpoints. A stated policy in the shareholders agreement prevents the yearly argument.

9. Take advice on the tax consequences

They vary considerably.

How money is extracted, when, and in what form has substantial tax implications that differ by jurisdiction and by structure. A conversation before the year end is worth considerably more than one afterwards.

Look back at the last three years and see what actually happened to the profit. Owners are frequently surprised to find how much was absorbed by decisions nobody made deliberately, and that review is usually what prompts the adoption of an actual policy.

Conclusion

Treat the allocation of profit as the strategic decision it is rather than as an end-of-year formality.

Establish what the profit genuinely is after tax, build a reserve covering several months of fixed costs before anything else, direct reinvestment at whatever is actually constraining the business, be honest about whether growth is the goal, consider debt reduction as a competitive use of the money, set the split as a policy in advance, agree it between owners before the year end, take advice on the tax treatment, and review what happened to the last three years of profit.