Surplus funds in a business account are usually indicative of a well-run company. Organizations with money left in their accounts after they meet their obligations tend to boast a healthy cash flow, decent profits, and an overall healthy business model.
On the one hand, surplus money praises the business and its owners. On the other, it creates opportunities for them to further expand profits and perhaps make a difference by investing in another worthwhile organization. It also creates an obligation to preserve the value of the extra cash.
Leaving the money in a business savings account, counting on the interest it earns is no longer an option. Inflation far outpaces interest, and such an approach is the recipe to letting the extra money wither away.
A business investment account can be the solution to protecting the value of the extra business cash and letting it generate some profits.
Investing in Stocks
Stocks represent an attractive investment opportunity for individuals and businesses alike. If your business has extra money sitting in the bank, it makes sense to use it to buy stocks and shares of other companies and gain exposure to other sectors of the economy through them.
The idea is simple. Use the money to buy shares in the companies you deem potentially valuable or hire an expert who can build a balanced portfolio for your investment. Sell the stocks later when they gain value, and add the profits to your surplus fund.
Corporations can also buy dividend-paying stocks and create revenue streams this way.
As your organization builds a war chest of cash, you can use it for strategic acquisitions, expansion, etc.
Those who choose to invest the surplus funds of their companies in stocks and shares should be aware that these types of investments are inherently risky. Stock prices may go down and result in losses instead of profits. If one turns a profit, the issue of taxes emerges. Both personal and corporate stock-based profits incur a capital gains tax in the UK.
- For individual investors, the capital gains tax can be 20%, 40%, or even 45%, depending on the amounts earned.
- Corporate tax rates on such profits can be as low as 19%.
- The same profit tax laws govern corporate capital gains as the other profits of companies.
There is a CGT-exempt amount individual investors may use to save money on their taxes. This amount is GBP 12,300 for the 22/23 tax year. If your profits exceed that amount, you are better off paying CGT as a corporation rather than an individual.
Those considering investing in stocks through their corporations should know that the 19% corporate tax rate will increase to 25% from April 2023. Businesses that qualify for the Small Profits Rate will continue paying 19% tax on their profits.
On the downside, investing in stocks is a long-term venture. It can take years, or even a decade, to turn significant profits on such investments.
Money tied up in stocks becomes illiquid. Organizations can withdraw or transfer money they have in their accounts, should an urgent need arise. They have to sell their stock first to get their hands on the money they invest.
Setting Up a Brokerage Account for Business
Small businesses looking to take full advantage of the surplus money they have may want to look into setting up a brokerage account. A brokerage account can work as an investment account, allowing the company to buy and sell stocks. In addition to that, it may offer other benefits, such as:
- Access to high-yield money market funds
- ATM privileges
- Interest-bearing checking accounts
- Paying wages and other expenses online
- Handling recurring payments automatically
- Tracking expenses
- Transfering funds between various accounts
Business brokerage accounts can be flexible, offering a customized set of features based on the needs of their owners.
Businesses considering setting up such accounts should compile a list of the features they find essential for their brokerage accounts. They may want to focus on the trading aspect, in which case they need competitive commissions. They may want to maintain low balances without having to pay penalties or use ATM cards that do not penalize non-bank withdrawals.
Once they know what they want in a business brokerage account, organizations can begin to look for companies that offer brokerage services. According to Forbes, entities looking to open brokerage accounts should stick to established firms and avoid new brokerages that offer suspiciously great deals.
Making a Loan to another Company
Another way for a business to invest in another organization is to make a loan. Company-to-company loans are not common and probably represent a riskier approach to gaining financial exposure in another organization, but they can work.
The gist of the investment scheme is to lend money to another company and earn interest in return.
The advantages of such loans are:
- In addition to generating income on the surplus cash, this investment approach allows businesses to support other businesses that may grow into profitable partners in the future.
- The recipient of the loans may prefer to get their funding this way as they may bargain for better loan conditions and more favorable rates than a bank could give them.
- The loan provider can gain exposure to a company that is unavailable through the public financial markets.
On the other hand, company-to-company loans have many disadvantages.
- The money that the loan provider gains through interest is subject to income tax.
- The inherent risks are significant as nothing can guarantee that the loan recipient can pay back the loan and interest.
- The law does not consider loans to be expenses, and the loan provider cannot deduct them as such.
- The loan provider must put together much paperwork to include due protections.
- The loan-receiving business may fail despite the best efforts of those leading it and thus become unable to repay the loan.
Investing in Funds
Investing in individual stocks and putting together a well-balanced portfolio requires expertise and effort. Instead of diving into the minutiae of such investments, businesses may opt to invest in funds.
Funds are ready-made portfolios of stocks that experts have balanced to offer exposure to various economic verticals and businesses. When an organization invests in a fund, it buys units in it that represent a set value. As the value of the companies and stocks in the index varies, so does the value of these units.
There are two main types of funds. Fund managers or investment experts select the constituents for some. Others are “passive” in the sense that an index or an economic sector determines their constituents.
FTSE 100 tracker funds track the constituents of FTSE 100 only. Investors may receive dividends if any of the constituents of the fund pay dividends.
The advantages of investing in funds are:
- Professionals handle the investment, and investors don’t have to do time-consuming research and hands-on management.
- With funds, investors gain instant exposure to diverse companies and economic sectors.
The disadvantages are, unfortunately, also significant.
- Investors lose access to the liquidity of their surplus cash, giving it up in the hopes of long-term gains.
- The profits investors derive from funds investments do not offer any tax advantages.
- The experts that manage these funds may charge steep management fees.
Money Market Investments
Money markets are reasonable choices for institutional investors. A money market deals in fixed-income securities with short-term maturity. Money markets offer fixed returns instead of the open-ended variable proposition of the stock market.
By investing in a money market, businesses can earn interest on their extra cash while preserving easy access to their funds.
One problem with money market securities is that they offer low returns. They are, in essence, IOUs from a large corporation or the government, and their returns are low-risk. One-year maturation offers businesses the same benefits as direct access to cash.
Money market deposit accounts do not charge fees on early withdrawals. Investors can, therefore, withdraw their money whenever they wish without incurring penalties.
Investing in Bonds
Government bonds are some of the safest investments though their yields are low. When they invest in bonds, businesses grant loans to entities like the government or other businesses. In exchange for these loans, investors get treasury bonds or corporate bonds.
The recipients of the loans pay the loan providers interest over a fixed period. In addition to the interest they earn, the loan providers can also make money by selling their bonds to other market participants for a price higher than the acquisition one. Bonds earn interest for those who hold them.
The main disadvantage of bonds is that the interest rates they offer may be low, depending on the economic and market conditions. Bonds that generate low interest are not attractive to secondary market buyers and may be impossible to sell.
Like most other business investment options, bonds tie up investors’ money. The only way to turn bonds into liquidity before maturation is to sell them.
Corporate bonds are riskier than government bonds. Corporate entities may fail and become unable to repay their obligations. Thus, their bonds turn worthless.
Government bonds do not carry such risks.
Buying real estate is always a sound business decision in times of low interest rates and economic uncertainty. With property, investors get a tangible asset that will almost certainly appreciate in value and can generate passive revenue.
Business investors can buy a property outright if they have enough surplus funds in their company coffers. In the UK, the average price of a house is GBP 283,000.
Companies that don’t have enough money to buy a property can make a deposit and take out a mortgage.
Real estate can generate money in two ways: through rent and by increasing its value over time.
Investors can combine the two types of profit, buying a house, renting it out for a few years, and then selling it for more than the purchase price.
Property investments aren’t carefree solutions, however. They carry a series of disadvantages like:
- A Stamp Duty Land Tax on the purchase
- Corporate or personal income tax on the income resulting from rent payments
- Capital gains tax on the profit resulting from the selling of the property
If a business takes out a mortgage to buy a house, it should make sure that it can make the payments. Otherwise, the venture can quickly turn into a liability.
When a business wants to sell a house to realize profits, it may not be able to find a buyer, or it may take a long time to find one. It is not easy to extract liquidity from a property.
Renting out a property takes time and effort. Tenants may degrade the house in time and thus subtract from its value.
Contributing to a Pension Fund
The main attraction of investing in pension funds is that it may result in many tax benefits. The UK’s pension tax laws are complex and convoluted. It makes sense to secure advice from an expert before opting for this form of business investment.
Putting corporate money into a personal pension fund may also be problematic.
Pension funds can be of several types.
- A stakeholder pension fund is one that someone else, an expert, manages for you. Such pension funds invest based on what the experts deem to be the safest and most profitable investments. On the upside, pension fund participants don’t have to worry about how the fund invests their money. Such pension funds represent a more hands-off approach to investing.
- Self-invested personal pensions give investors greater liberty in making investment decisions. Those with the skills and resources to operate such investments will opt for these pension funds over private or stakeholder solutions. Through pension funds, investors can access a wide range of investment vehicles.
The tax benefits that pension investment can create for businesses are considerable.
- In the UK, the Annual Allowance for pensions is GBP 40,000 for 22/23. Below that threshold, businesses receive tax relief at the marginal rate of Income Tax.
- Employer pension contributions from already taxed company income are expenses according to the law and, therefore, are eligible for Corporation Tax relief.
- Direct contributions to employees’ pension funds are eligible for Corporation Tax relief and are National Insurance-free.
Although contributing directly to employee pension funds does not generate revenue for a company, it is an effective way to reduce organizational tax obligations. Employees will also appreciate the perk which is likely to increase the organization’s recruitment power and employee retention.
Money invested in a pension fund becomes illiquid for a long time. Pension fund investors can only access their money after the age of 55. The UK has extended this age to 57 from 2028 onward.
Another downside of this investment method is that the Annual Allowance rate limits tax-efficient investments and the overall potential of the method.
If you have a limited company with a large cash reserve, you may want to extract money from it in the form of a loan. In the UK, there is a legal framework that defines how you can accomplish that.
You should exercise caution, however. Treating the company as your personal piggy bank is not a healthy approach to dealing with its surplus cash, on the one hand. On the other hand, abusing the loan option carries significant tax-wise implications.
Loaning money from the company has been possible since the 2006 Companies Act allowed it. The Directors Loan Account (DLA) contains a record of transactions between the company and the director, also allowing the latter to loan money to the company in times of need.
If, according to the DLA, the company owes money to the director, the latter can withdraw money without incurring any tax implications. If the director already owes money to the company and wants to extract more, tax implications emerge. If there is an outstanding balance in the Directors Loan Account at the end of the company year, it triggers an S445 charge. The charge results in a 32.5% corporation tax return on the outstanding balance. If directors repay the loans from their companies within nine months and eliminate the balance, the charge will be recalculated.
The DLA balance may cover overpaid expenses and salaries or dividends paid out in excess of profits.
Money that people loan interest-free from their companies is a taxable benefit. The size of the taxable benefit depends on the official rate of interest, which was 2.5% for 2019/2020. Beneficiaries must pay tax on their benefits according to the law.
Directors can also write off loans from their companies according to the 2005 Income Tax Act. Loans carry tax obligations in this case as well.
If the director loans money to the company to fund expansion or equipment purchases and charges interest on the loan, the interest incurs tax obligations.
How every company invests its surplus money depends on its needs and goals. Keeping the money in a bank deposit and not bothering with extracting more value from it is also an option. In some cases, it may make sense for organizations to set up separate companies to manage their investments.