Is Cash in Your Pocket Bad for Your Business? | SunTrust Resource Center

Financing and Capital Markets

Is Cash in Your Pocket Bad for Your Business?

Retaining Enough Cash in Your Company to Fund Future Growth.

Is Cash in Your Pocket Bad for Your Business?
 

There’s an old business adage that states “revenue is vanity, cash flow is sanity, but cash is king.” Unfortunately, for many mid-sized business owners, it’s the latter part of that saying that seems to resonate especially well. And as a result, the landscape is littered with once highly successful small and mid-sized enterprises that suddenly find themselves struggling to stay afloat.

As their businesses finally turn the corner and become profitable, many entrepreneurs who have personally sacrificed for years to build their companies have a natural and understandable desire to begin enjoying the fruits of their hard labor. In fact, it’s not at all uncommon for owners to be extracting nearly 100% of net income out of the company. What they fail to consider, however, is that by taking all the money out of their business they are de facto leaving it highly levered and assuming significant undue business risk in the process.

It’s an immutable business truth that managing cash flow is vital both to the survival of your business as well as to its long-term viability and growth potential. But the challenge that many owners of mid-sized firms struggle with is finding the optimal mix of how much cash they can safely extract from the firm, and how much should be retained in order to fund the continued growth and expansion of the assets in the business.

Striving for stability and sustainability

There’s no shortage of examples out there of mid-sized firms that have grown from $30 million to $100 million over a long period of time without ever assuming excessive risk or becoming highly leveraged. Instead, these companies are typically captained by CEOs who are committed to steady, sustainable annual incremental growth goals, and who have successfully stayed the course.  

Those firms represent a small and distinct minority. Often, in sitting down and consulting with clients we encounter ballooning balance sheet debt and rising business risk that’s directly attributable to the owner(s) taking too much equity out of the business.

As a case in point, let’s look at a hypothetical export and trading company that’s generating a steady $15MM in annual sales and, because of that industry’s relatively thin margins, is throwing off about $500K in net income each year. Rather than retaining some cash in the business, the owner has been extracting the entire $500K (with $200K of that earmarked for taxes and $300K taken as a withdrawal). Assuming that the company’s inventory and receivables are approximately $2MM and the owner can finance half of that, the owner will need to maintain $1MM in equity.

But here’s where the difficulty arises. Consider what happens if that $2MM in inventory and receivables increases by a mere 10%. Since he can only finance half of that increase ($100K), suddenly the owner may struggle to find a source of funds for the other $100K. With no retained income left in the business, that money will ultimately need to come directly out of the owner’s pocket.

Finding the right balance for your business

To rectify this problem and ensure that the business retains sufficient cash to fund continued growth and expansion, the owner must understand that he or she can only take a percentage of the net income, and to determine based on the individual owner’s needs and the anticipated needs of the business exactly what that allocation should look like. If future business growth is a secondary consideration to personal income needs, then perhaps a much smaller percentage of net income will be retained.

In the case of our trading and export company example, however, the owner has aggressive plans for continued expansion into new markets. In light of that, an optimal solution for this business would likely necessitate that a sizable allocation of cash generated(perhaps as much as 40%) be retained in the business.

Determining what is right for you and your company will be driven by a host of factors unique to you and your business, not the least of which are the tax considerations and implications associated with various strategies. There’s no one-size-fits-all solution. But if future growth is even a remote consideration, now is the time to begin exploring ways that you can begin retaining equity in your business to fund tomorrow’s growth.

This content does not constitute legal, tax, accounting, financial or investment advice. You are encouraged to consult with competent legal, tax, accounting, financial or investment professionals based on your specific circumstances. We do not make any warranties as to accuracy or completeness of this information, do not endorse any third-party companies, products, or services described here, and take no liability for your use of this information.

Related

Investment and Insurance Products:

Are Not FDIC or any other Government Agency Insured   Are Not Bank Guaranteed  May Lose Value 

© 2018 SunTrust Banks, Inc

equal housing logoSunTrust Bank is an Equal Housing Lender. Member FDIC

equal housing logoEqual Housing Lender. SunTrust Mortgage, Inc

SunTrust, SunTrust Mortgage, SunTrust PortfolioView, SunTrust Robinson Humphrey, SunTrust Premier Program, AMC Pinnacle, AMC Premier, Access 3, Signature Advantage Brokerage, Custom Choice Loan and SunTrust SummitView are federally registered service marks of SunTrust Banks, Inc. All other trademarks are the property of their respective owners.

Services provided by the following affiliates of SunTrust Banks, Inc.: Banking products and services are provided by SunTrust Bank, Member FDIC. Trust and investment management services are provided by SunTrust Bank, SunTrust Delaware Trust Company and SunTrust Banks Trust Company (Cayman) Limited. Securities, brokerage accounts and insurance (including annuities) are offered by SunTrust Investment Services, Inc., a SEC registered broker-dealer, member FINRA, SIPC, and a licensed insurance agency. Investment advisory services are offered by SunTrust Advisory Services, Inc., a SEC registered adviser. GFO Advisory Services, LLC is a SEC registered investment adviser that provides investment advisory services to a group of private investment funds and other non-investment advisory services to affiliates. Mortgage products and services are provided by SunTrust Mortgage, Inc.

SunTrust Mortgage, Inc. - NMLS #2915, 901 Semmes Avenue, Richmond, VA 23224, 1-800-634-7928. CA: licensed by the Department of Business Oversight under the California Residential Mortgage Lending Act, IL: Illinois Residential Mortgage Licensee #MB-989, Department of Financial and Professional Regulation, 100 W. Randolph, Suite 900, Chicago, IL 60601, 1-888-473-4858, MA: Mortgage Lender license #-ML-2915, NJ: Mortgage Banker License - New Jersey Department of Banking and Insurance, NY: Licensed Mortgage Banker—NYS Department of Financial Services, and RI: Rhode Island Licensed Lender.

"SunTrust Advisors" may be officers and/or associated persons of the following affiliates of SunTrust Banks, Inc.: SunTrust Bank, our commercial bank, which provides banking, trust and asset management services; SunTrust Investment Services, Inc., a registered broker-dealer, which is a member of FINRA and SIPC, and a licensed insurance agency, and which provides securities, annuities and life insurance products; SunTrust Advisory Services, Inc., a SEC registered investment adviser which provides Investment Advisory services.

SunTrust Private Wealth Management, International Wealth Management, Business Owner Specialty Group, Sports and Entertainment Group, and Legal and Medical Specialty Groups and GenSpring are marketing names used by SunTrust Bank, SunTrust Banks Trust Company (Cayman) Limited, SunTrust Delaware Trust Company, SunTrust Investment Services, Inc., and SunTrust Advisory Services, Inc.

SunTrust Bank and its affiliates do not accept fiduciary responsibility for all banking and investment account types offered. Please consult with your SunTrust representative to determine whether SunTrust and its affiliates have agreed to accept fiduciary responsibility for your account(s) and if you have completed the documentation necessary to establish a fiduciary relationship with SunTrust Bank or an affiliate. Additional information regarding account types and important disclosures may be found at www.suntrust.com/investmentinfo.

SunTrust Robinson Humphrey is the trade name for the corporate and investment banking services of SunTrust Banks, Inc. and its subsidiaries, including SunTrust Robinson Humphrey, Inc., member FINRA and SIPC.