There comes a time with a profitable business where you have the opportunity to take money away from working capital and use it to generate investment returns outside of your main business. The company has many choices about what to do with retained earnings, which include paying down debt or investing elsewhere for a higher return than the cost of keeping the debt in place.
What are the choices for a profitable business to get an investment return outside of their operations?
Buy a Smaller Competitor
Depending on the amount of profit retained and access to funding, it may be possible to embark on a steady plan to scoop up smaller competitors one by one over the years. Doing so means acquiring their customers, staff, and knowledge, and merging it into the current operations. The hope is that as well as having an increasingly dominant position in the marketplace, the business will also use economies of scale to reduce overall staff levels and get better supplier deals from larger order values.
High Dividend Paying Equities
Going to the stock market to buy individual stocks that pay a respectable 4-7% cash dividend is a useful way to throw off plenty of fresh cashflow while retaining the original investment. The underlying investment typically still manages to grow with inflation, unlike most bonds that pay an interest payment but do not grow in value.
Investing for dividends works well as long as the investor doesn’t reach too far for yield. Stocks can be bid up beyond a sensible valuable point, which lowers the future income for the business. Therefore, there needs to be good valuation analysis, such as that conducted at dividendmantra.com, to pick the companies that are still fairly valued and throwing off a good amount of juicy cash dividend income too.
Start a Second Business
Creating a new company at a different end of the same industry is an interesting approach to take. Sometimes the higher sticker price and the way the first business is setup doesn’t permit offering an economy product. The airline industry is a good case in point for this where the staff being unionized prevented many airlines from offering budget flights. As a result, many co-owned budget airlines were born.
The original company is still able to leverage their existing relationships with suppliers and industry contacts to get better deals than the usual startup could achieve, which makes the newer business more profitable sooner. Fresh blood in the form of new employees who don’t have the same mindset as the group think in the existing business is also a good way to take a different approach to business number two.
Companies have many options when considering what to do with extra cash in the business once they’re nicely profitable. Leaving an excess balance in the business checking account rarely makes sense outside of cash needs for the next year. Beyond that, there’s better ways to invest the spare cash to get a higher return on investment. Investment returns show up in the financial reports and look good from a management standpoint too.