Speculate to Accumulate.

Sarah Wilson writes So, we're coming to the end of the present tax year, and you've got all this spare cash sloshing around in your limited company. What are you going to do with it?

A common approach of director-shareholders is to treat their companies rather like a magic piggy bank. The more restrained will simply leave the funds in the company for a 'rainy day', possibly with a balance of several thousand pounds sitting in the business account earning negligible levels of interest. Others take the 'Christmas' approach, drawing out all the funds, taking the 40% tax hit, and scouting around for a new toy - cars, motorbikes, planes etc. Then there's the careful hoarders, who draw all the funds from the company, take the proceeds (minus 40% tax) and, er, stick it in the Provincial Mutual's 90 day notice account earning 3.6% net interest. (The UK stock market has returned, on average, 12.2% per annum over the past 80 years Ref 1).

Now, back to my point of what you are going to do with the business's spare funds. As a hard-headed business person, you will have no doubt spotted the folly of the three approaches outlined above. Haven't you? Well, giving you the benefit of the doubt for the moment, we'll move on to what you could choose to do with the money.

Putting your shareholder hat on its peg for a moment, you are a director of a private limited company. The main reason for the existence of your employer (the limited company) is to make profits. The employees (revenue generating and non-revenue generating), the shareholders, and the directors all may have their own personal motives, but without profit, no company can trade in the long term. Like the directors of FTSE-listed firms, you have a choice of how to allocate your company's resources, subject to shareholder approval.

Shareholders like dividends. It reminds them that the company is actually making a profit, that their initial investment was a sensible choice, and that the directors know what they are doing. But dividends are taxed, so astute shareholders don't just want to see profits distributed. The pension funds and insurance companies who invest in the FTSE expect to see some sort of long-term growth. The Halifax makes lorry-loads of cash each day, but has fallen out of favour with the City recently because its growth has faltered. As a company director, you have a responsibility to your shareholders to look to the long-term growth and health of the company.

A company can grow in all sorts of ways. It can increase revenue, increase net profits, increase its market share, diversify, buy or merge with other businesses and so on. Your company is no different. Let's look at an example:

Your company's revenue-generating employee is currently pulling in £30 per hour as a Cisco router consultant. If you, the director, send the employee on a CCIE training course, the company will have to pay out at least £15,000 in fees, plus she will lose around 5 weeks of fee earning hours on courses, travel and so on. So, the total outlay is at least £21,000. Once CCIE qualified, you expect that your employee should be able to command £45 an hour. Over one year, this would equate to a before tax increase in company revenue of around £25,200. This gives the company a return on its initial investment of 20% in the first year. The risk is that your employee won't be able to increase their rate, or even pass the test, in which case the company will lose its twenty-one grand. Is 20% worth the risk?

CCIE certainly looks very impressive on business cards, but as the director of a limited company, you need to consider the pure business case. You have to weigh up the best option for your company, given the likely risks and rewards.

By investing, you are practising what psychologists would call delayed gratification. If you have children, you've probably been pestered for the latest toy. And you may have responded in a loving, even handed manner that little Tobias must save his pocket money if he wants a Super-Pokospice-Starfighter. Or you may have snapped and bought him a packet of crisps to shut him up. The first option, idealistic though it may sound, is introducing little Tobias to the fundamentals of investment. If he goes without today, he can have much more tomorrow.

With your employee hat on, you may want to draw down all the company's surplus, take the 40% tax hit and blow it all on… well… hats. However, as a director of a small but growing business, this should be the last choice on your list. As a shareholder, after paying for personal necessities, you should be looking for long-term growth in your investment.

An entrepreneur is defined as 'an individual who assembles and organises factors of production to undertake a venture with a view to profit' Ref2. Richard Branson is a squillionaire icon and he is probably one of our country's best examples of entrepreneurship. He spots an opportunity in a particular market. He ploughs capital in, often a mixture of his own money and other people's. He brings together the people to build the business (note: Richard Branson may have founded Virgin Records, but he is not a pop singer, nor a vinyl-pressing expert). Finally, when the business is established and profitable he sells a large chunk off at a huge profit. Branson built his business empire from scratch. He now operates on a multi-national scale, but we all have something to learn from his example.

Like Branson, you can use the residual profit from your core business, e.g. computer consultancy, to grow and expand. Opportunities exist in every facet of life – your new area of expansion may be totally unconnected to what you are doing now, or anything you have done in the past. In evaluating potential new business opportunities, ask yourself the following questions:

1. How much will the company need to spend? (Remember that company money is not the same as your money – it's taxed differently for starters.)

2. What is the likely return on this investment?

3. How long will it take for revenue to come in from this investment?

4. What are the risks?

5. Is there a better place for the company's money, e.g. another business venture, stock market investment?

For some of you, this will all be old hat (hats do seem to be a recurring theme here, don't they?). For others, this whole thing of being a 'proper' business with all the concomitant risks, rewards, and let's not forget fun, may be giving you a headache. To finish up with, here's a little risk-reward exercise to get you into the entrepreneurial frame of mind. There's no right or wrong answer as such, but it may give you an idea of your present position on the Branson – Del-Boy scale.

You have £10,000 residual cash left in the limited company. All company tax liabilities, fees and so on have been accounted for. Cumulative shareholder dividends for the current tax year have put all shareholders into 40% tax. Choose one of the five options below for the £10,000.

1. Leave it in the company, but invest in a FTSE350 tracker fund with fees of less than 0.5% per annum and a historical return of not less than 6% per annum over the past five years.

2. Your mate's cousin works in the stables at Callaghan's Horse Training Emporium. He reckons Who's A Ducky, an 8 year old gelding, stable name 'Dobson', is a certainty for the 14:35 at Chepstow next Friday. Current odds are 34-1.

3. The bloke at the garage where you get your Kia serviced does engine tuning and is popular with local tradesmen. He could charge a lot more for tuning HGV engines, in fact, he's had a few enquiries, but the diagnostic equipment required costs at least £8,000 and the bank's not interested. He would consider a 50-50 profit split if someone would take on the capital risk.

4. There's a metallic magenta Lotus Elise on the forecourt of Thrusts of Loughborough this week. R-reg, nice condition, if you traded in the Kia, raided Tobias's piggy bank, and drew the £10,000 (minus the 40% tax, naturally), she could be purring her way to Sainsburys with you firmly grasping her leather-encased wheel.

5. You've spotted an advert in the back of this month's Private Eye, reading thus:

'Exciting International Investment Opportunity! Entrepreneur's sought for new boom industry in Myanmar! Be part of the cuttlefish-farming revolution! Send a check (sic) payable to YITI for 600,000THB* to this address: Yitherepthai International Trading Inc, Room 34226 Hynwapthang Lokko, Phonsavan, Laos.'

*600,000 Thai Baht is around 10,000 UKP.

Sarah Wilson

Ref 1 Credit Suisse.

Ref 2: Collins Dictionary of Economics, 2nd Ed, HarperCollins (1993).

Notes on the Author

After studying Japanese and Economics at Leeds University, Sarah went to work as a systems analyst at the Halifax. She then went Contracting for a couple of years, but now writes full time for, amongst others, the Women's Finance column on the Motley Fool web site.