I remember making my first dollar when I was about eight years old. After washing my dad’s car in our driveway with a hose and a bucket of soap, he presented me with a crisp dollar bill (I suppose I made 50 cents an hour back then). At first, my mind whirled with possibilities. My neighborhood had an ice-cream truck, after all. I truly couldn’t decide what to do with this fortune so I figured I would wait until a worthy purchase came along. I didn’t have a wallet at that age, so I found a little drawstring bag and carefully stored the dollar inside. I ended up losing that bag (as eight-year-olds do) and finding it years later under my bed. In the interim, there were many times it would have been nice to have a dollar on hand. When you find yourself wondering what to do with a surplus or unexpected money, don’t let your extra money go to waste by being non-strategic. No matter how you come into your surplus, be it large or small, you and your small business can multiply the benefits of having extra money on hand.
PLANNING FOR A SURPLUS
Individually, if you identify goals for how you will spend the money (ideally before you’ve received it), this will help you to avoid blowing your money on less important expenses and regretting it later. When businesses get extra money, the main issue can be not keeping track of it because there isn’t a place to document it in the budget or there isn’t a plan in place on how to use this money to the best advantage of the business. This can lead to unintentionally spending the money in less desirable ways.
One practical way an individual or business can plan to use their surplus is for upcoming expenses. In your personal life, it can be beneficial to pay down credit cards with high interest rates before putting the rest of your extra money in savings or investments. You can also put your money toward student loans to decrease their length and the interest you’ll end up paying over the life of the loan. For a business, some debt financing can actually be good because of the tax deductions you get on the accrued interest. You will want to make sure your debt-to-equity ratio is not too high but, if you are in a good place, it might not actually be in your best interest to wipe out your business debt in one fell swoop with the extra money. You could plan to use it in installments for upcoming monthly loan payments instead. Other upcoming business expenses you could plan to use the extra money for are pesky fees and subscriptions.
If there isn’t an immediate need to take care of existing expenses or plan for pressing future ones, another area that you can plan for when considering what to do with extra money on hand is planning for the growth of your business. Investing in the growth of your business could mean improving an existing product, expanding your marketing, or hiring new employees. You’ll want any decisions you make to use a surplus in this way to lead to a sustainable increase in cash flow overall in order to maintain these upgrades.
SAVING YOUR EXTRA MONEY ON HAND
Everyone wants to be better at saving. When it comes to having extra money on hand, it’s hard to go wrong with choosing to save it. For your personal life, consider putting extra money aside for the short-term and long-term goals you have. Short-term goals may include travel plans, important events, or paying toward some of the upcoming expenses mentioned above like high-interest credit cards. Long-term goals may include savings for retirement, children’s college tuition, and paying off your mortgage. As a business, putting your extra money in a business savings account can increase your business credit score, generate some interest, and allow you to have capital set aside for tax payments that you may not remember to save if you only have a business checking account that you regularly draw from.
For both individuals and businesses, it is paramount to have an emergency fund. Having extra money on hand can be a great opportunity to save for this specific need. An emergency fund is a liquid fund that can typically cover three to six months of all your expenses, if need be. In your personal life, this is essential in case you unexpectedly lose your job, have a medical emergency, or suffer major damage to your car or home. An emergency fund provides peace of mind as well as a practical safeguard from going into debt. As a business, you may experience cash flow lulls depending on the market, time of year, or other variables. Studies by the U.S. Bank and U.S. Bureau of Labor Statistics show that 82% of small businesses fold because of cash flow issues. Having an emergency fund will allow you to continue business as usual during those times. Additionally, not all emergencies are bad. A sudden, time-bound opportunity may arise for your business and you will want to be prepared for that moment as well.
MAKE MONEY WORK FOR YOU: THE POWER OF INTEREST
Having extra money on hand can be a great opportunity to make your money work for you through the power of interest. We briefly touched on how you can earn some interest through a savings account but there is much more to it.
Interest is a percentage of the principal sum borrowed or deposited that is paid to the lender or financial institution where you have your account. Borrowers pay interest to lenders and financial institutions pay interest to account holders. Interest comes in many shapes and sizes. The categories we will cover in this article are simple interest and compound interest. Simple interest is based on the principal sum borrowed or deposited and doesn’t change. Compound interest is a very different story. Albert Einstein is credited as proclaiming that “compound interest is the 8th wonder of the world.” Truly, it can give you massive returns on your savings. The idea of compound interest is that by reinvesting your previous interest back into your account, your interest earned will be higher the next time because it will be based on this new, higher sum. This exponential growth cycle will compound daily, monthly, or yearly, depending on your bank’s terms. Simply put, your money makes more money just by being in that account. If you are a borrower, on the other hand, be cautious about compound interest: if you don’t pay your lender by the stated due date, interest will accrue on the interest you did not pay and you will have to pay more at the next due date.
Compound interest can be very rewarding for individuals and businesses who deposit into high-interest accounts. As opposed to checking or savings accounts, higher interest returns can be attained through a Certificate of Deposit (CD). This type of account offers high interest in return for leaving a lump-sum deposit in the account until the maturity date is reached. There are CDs available for individuals and commercial CDs for businesses. Some banks and credit unions apply fees for opening an account while others are more flexible with no fees and more liquid CD options. There are often penalties for moving your money out of a CD prematurely so you’ll want to consider whether a traditional CD or liquidity (no-penalty) CD is best for you and your company. If you have a CD account with compound interest, saving your extra money can accrue big gains over time.
INVESTING YOUR EXTRA MONEY ON HAND
Many people who find they have extra money on hand will choose to invest it. As an individual, a common investment is in the stock market. When you buy stocks, you are investing in a company and are essentially purchasing a small part of that company’s earnings. One way to profit from stocks is by selling when the price of your shares exceeds what you bought them for. General practice is to hold onto stocks for the long-run and wait for a seller’s market. Some companies also pay dividends to their shareholders. Stocks can be a risky investment, however, since companies can go out of business at any time or simply lose value making your shares worth less than when you bought them.
Bonds are another common investment. These are loans that you can make to government entities and businesses. As with most loans, you are paid back with interest from your borrowers. While this is generally a less risky investment than stocks, it also does not offer as high of returns. Diversifying one’s investment portfolio with stocks, bonds, and other activities can help mitigate risk in any one particular area.
As discussed above, one of the most important investments a small business owner can make with extra money on hand is to reinvest back into the business by generating an emergency fund, engaging in growth activities, and other strategic moves. It’s important for small business owners to strike a balance between diversifying their personal investment portfolio and putting money directly back into the business. Outside of an owner’s personal wealth, it is possible to invest business profits in stocks and bonds as well. However, in order to create a positive feedback cycle, small business owners will commonly choose to reinvest extra money generated by profits back into the business. Some areas of your business to reinvest in are discussed above in the planning portion.
Having extra money on hand can change a lot for you and your business or it can change nothing at all. It all depends on what you do with it. Move forward wisely by strategizing and making that extra money a part of your long-term growth. If you don’t have a surplus at the moment, we encourage you to plan so that when that day comes, you’ll be ready.
