Reinvestment is the practice of taking some of the profit of your business and investing back into the business. Given today's global market place and competitive pressures, it is arguable that a failure to reinvest back into your business guarantees the failure of your business.
Reinvestment can take many different forms. It can be:
- An investment in software to reduce labour cost
- An investment in technology to improve efficiency
- Product innovation or new product lines
- Expanding into new markets
- A re-brand, a new fit out, a new website
While reinvestment can take many different forms, there are 3 main reasons as to why you should reinvest back into your business:
- Cost management
- Competitive pressures
- Capturing new opportunities
How do you know when you should reinvest back into your business?
The answer is simple – ALWAYS. Each year you should set aside a portion of your profit to be reinvestment back into the business. The danger of not doing so, is that, at some stage, something will break (either physically or in your business model) and the cost of fixing it will be overwhelming.
How much should you reinvest back into your business each year?
This will differ for each business and may differ from year to year. There is no simple formula, but some good planning will help you determine the amount. In your 3-5 year planning, consider what investment is likely to be required (for example machinery of software approaching end of life), as well as what is desired (for example new products or a re-brand). Cost this out and put funds aside periodically for these projects.
How do you reinvest without sufficient profit?
At times your business may require reinvestment, however you do not have the funds available or sufficient profit to save the funds in the near future. If you determine the reinvestment is essential you can look at 2 other funding sources:
- Lenders – you can look at different types of loans such as overdraft, equipment finance, debtor finance, commercial loan and so on. You can look at traditional lenders, such as banks, or some of Australia’s new breed of lenders, such as Banjo Loans, Judo Capital and True Pillars
- Investors – investors will consider investing in your business either for a cost (ie charge you interest) or for a shareholding. If it is for a shareholding, you will need to determine a value for your business in order to establish how many shares should be offered for the required investment level. Valuing a business for an investor is different to valuing a business for normal lending purposes.
How do you determine your reinvestment strategy?
Planning your reinvestment strategy is of utmost importance, especially if you are borrowing or brining in investors. There are 2 methods that can assist you to determine your reinvestment strategy:
- Cost–benefit analysis – This is a systematic approach of analysing the costs of investment strategies against the benefits of that investment strategy and comparing a number of alternatives to determine which one should win out. Financial modelling is a great tool for this analysis and comparison work
- Return on investment – This is a ratio between the net profit and the cost of the investment, to determine whether the reward of the investment strategy will generate the desired level of profit
A reinvestment strategy requires both accounting and commercial disciplines and a CFO is perfectly positioned to work with you as the business owner or CEO of the business to make these very important strategic decisions in your business.