A wise person once said, “You have to spend money to make money.” And though it’s a bit oversimplified and overused, the central point remains true. Growing a business takes more than just a good idea, especially when trying to compete with large, well-established entities. This is particularly true in the E-commerce world, as the COVID-19 pandemic has shifted a huge portion of consumer spending to web-based platforms.
So, how do you decide just how much money to spend on your business? And where do you draw the line between reinvesting in the business versus investing in your personal financial future? As with most things in life, there is no clear-cut answer, but here are some points to consider along the way.
What Is Reinvesting?
Reinvesting is the process of redirecting a portion of your profits back into the business. This is different from just saving them in a business account. Reinvesting is an active process whereby certain areas of the business are targeted for improvement. Common areas chosen for reinvestment include digital marketing, payment processing, website design, technology, talent, and customer service.
There are many reasons to reinvest in your E-commerce business, including:
- Increasing growth: When targeted effectively, reinvested funds can lead to an exponential increase in your company’s value and profit-earning potential.
- Reducing taxes: Money reinvested in your company is considered a business expense and is therefore not taxable as income.
- Preventing stagnation: In today’s world, if a small business isn’t growing, it’s dying. There is simply too much competition and technological change to keep up with if you’re not consistently reinvesting in your business and your team.
- Improving productivity: Oftentimes the question of where to reinvest is answered through trial and error. By consistently redirecting your profits to areas like marketing or content design, you’ll start to understand which reinvestment strategy is most effective for your business, and the money you spend will become much more productive.
When to Reinvest?
Reinvestment can only occur once your business begins to make a profit above and beyond your operating expenses and overhead. The amount available for reinvestment is calculated by subtracting business expenses (including your own bare minimum salary), taxes, and any long-term liability payments from total revenue. If this is a positive number, you can (and should) start reinvesting!
How Much to Reinvest?
Most entrepreneurs will tell you to reinvest 30%-50% of your available profits back into your business. This is generally a good guideline, but it should always be considered in the context of your specific financial situation. Remember: reinvesting in your business is important, but it should never put you in a negative cash flow situation and it should always be paired with a solid reinvestment strategy.
Investing in the Market Instead
Many business owners wonder if it’s smart to invest all or nearly all of their profits back into their business. Shouldn’t you pay yourself while you can? After all, 50% of small businesses fail within the first 5 years, and 82% of those failures are caused by cash flow issues. This is a valid concern and one that can be addressed by investing in assets outside of your business.
For instance, many business owners allocate a percentage of profits toward building a personal investment portfolio. This can be used as a way to diversify assets and create a relatively liquid source of emergency funds. Investing in the market can be a good way to hedge your bets against the risks associated with a small business.
But just because there are risks, doesn’t mean you should completely forgo reinvesting in your business in favor of investing in the market. Most solutions are not found in an all-or-nothing approach. Instead, investing in the market should be considered part of your overall reinvestment strategy.
Schedule an Appointment Today
No matter what stage of life your E-commerce business is in, it’s important to have a plan when it comes to your profits. With a clear idea of where you want your money to go and what you want your company to look like, you can be more purposeful and profitable with your decisions. Tree Street Advisory can help you determine the right course of action for you and your eCommerce business. Call (615) 219-9802 or schedule a free 30-minute introductory appointment here.