Financial Director, the online business magazine recently interviewed David Eaton of SME Strategies. Shannon Moyer of Financial Director asked David for his thoughts on one of the conclusions in the recently produced report by Allicia Bank on the question for SME owners “How much of our profits should be reinvested?” The rate is 9% of profits are reinvested back into the business by the best performing SMEs according to Allicia.
However David, whilst agreeing that investing in a business is key, pointed out in his interview that choosing a percentage of net profits is likely to be too simplistic an approach. David believes it is essential to know what costs have been included in arriving at the net profit in the first place! A sound business will be spending on marketing, training, innovation, renewing equipment etc as part of its annual budget. So perhaps a better question is to ask how much of our income should be given over to such areas?
Covid-19 has brought more and deeper challenges than most SME businesses owners have seen in their lifetime. Cash flow is under pressure like never before so re-investing cash back in the business can appear discretionary spend to be avoided.
Whilst some costs can be deferred in a crisis, if the cost is genuinely needed (and is not a luxury unlike upgrading the owner’s Jaguar!) then the spend should not be deferred for too long.
But do we need to go on reinvesting profits?
Yes, but the amount of reinvestment will depend on the stage of the business in its life cycle. Whilst some reinvestment will always be needed just to ‘stand still’, to grow the business will probably require much more reinvestment.
A start-up firm by definition needs to grow into an established business and this requires investment but whether further growth is then needed depends on the vision of the owners. Is it to grow further or has the business become a good size and is now producing the required returns for the owners? These businesses that have reached a satisfactory size are often known as ‘lifestyle businesses’. We have huge numbers of them amongst successful SME firms in the UK. As businesses expand and grow, so new skills in management are needed by the owners. Much more time will be needed to be spent working ‘on the business’ rather than ‘in the business’ and not every business owner wants to do that. They are satisfied with what they have created.
Growth for the sake of growth is not a prerequisite. What is a prerequisite though is to invest back in the business so it continues to be successful in its marketplace which may well change. Competitors are likely to encroach on the business and need to be warded off.
There are not necessarily right or wrong answers to these big questions about a business’s size or “How much of our profits should be reinvested?” Using a mentor can though really help a business owner to think hard to identify their drivers and goals. This will help them journey to the destination they actually want rather than the destination they think they ought to go!
At SME Strategies, we are pleased to be part of the Association of Business Mentors which gives unrivalled support to owner managed businesses.
Six strategies for SME success
The Allicia Guide to business success has six great key pointers:
1. Regular training for staff
2. Focus on innovation and technology
3. Having a long term vision
4. Broaden your customer reach
5. Develop a reinvestment plan
6. Don’t be an introvert
The Allicia Guide can be downloaded here.
Call us at SME Strategies for a complementary conversation about ways to help your SME business not just survive but grow in these challenging times of Covid-19. We can help you identify the key strategies to enable your business to flourish. “How much of our profits should be reinvested?” might well be a very good question to start a conversation.
07841 215182 firstname.lastname@example.org