If your limited company is making a profit, you may find that you have surplus cash in the business at the end of your financial year, or company ‘year-end’. This is excess money beyond what is required to run the business. While retaining extra cash in your company might seem like a good idea, it can present certain problems further down the line.
How you decide to manage this surplus cash is entirely up to you, but there are many good options available, which we outline below. But we’ll start by explaining what surplus cash is and why it can be problematic to keep this money in your limited company.
What is considered ‘surplus cash’?
Surplus cash is the additional money you have in your company that exceeds the amount required to run the business. It doesn’t simply refer to the actual cash you have in your company bank account, since most businesses have a certain amount of money earmarked for future use and payments falling due from clients or other sources.
Whilst there is no simple formula, it’s best to consider retained profits to accurately work out how much is needed for working capital and how much is surplus. To do this, you need to forecast your business income and expenditure for the current financial year.
When doing so, you will need to take into account all business costs and liabilities, including:
- Mortgage or rent payments
- Utility bills and business rates
- Stock, supplies, and equipment
- Staff wages, including directors’ salaries and employer’s National Insurance contributions
- Staff pension contributions
- Funds earmarked to pay dividends to shareholders
- Corporation Tax and VAT
- Loan repayments
- Banking charges and interest
- Accountancy fees
- Broadband, phone, and software costs
It’s important to remember that not all liabilities are paid in the tax year in which they arise. Most companies have cash accumulating in their business bank accounts to cover such costs, namely Corporation Tax (due 9 months after your company’s year-end) and VAT (due every quarter). This is why it is unreliable to consider only cash in the bank.
Potential problems from retaining too much surplus cash
Ideally, you should try to retain additional funds in your company to cover contingencies. Three months’ worth of outgoings is optimal. Any more than that can be a missed opportunity to make good use of the money.
More importantly, retaining too much surplus cash can cause problems further down the line with succession planning or selling your company. You could end up facing significant tax liabilities and issues with certain tax reliefs, such as Business Asset Disposal Relief (formerly known as Entrepreneur’s Relief) and Business Relief (formerly known as Business Property Relief).
If your company has distributable profits of more than £25,000 upon winding up, you will be liable for dividend tax on this income. Depending on your total personal earnings for the year, this could push you into the higher-rate or additional-rate tax bands.
However, where there is less than £25,000 surplus cash, the distribution of profits will be subject to Capital Gains Tax instead. This may result in a substantially lower tax liability, due to the annual CGT allowance and the potential availability of Business Asset Disposal Relief.
With regard to Business Relief when passing on a company (e.g. to your children), HMRC may treat the business as an investment company if there is an excess of surplus cash.
In such instances, you would either be ineligible for Business Relief for Inheritance Tax or subject to restricted relief. Without a buildup of cash, the business, shares, and assets would qualify for tax relief of either 50% or 100%.
10 effective strategies for utilising surplus cash
If you find yourself in the fortunate position of having extra money in your limited company, it is better to utilise this surplus cash rather than letting it sit idle and accumulate. There are several ways that you can make it work in your favour over both the short term and long term. Let’s take a look at some of these options.
1. Make early repayments on business loans
Taking into account how much interest you are currently paying on any business loans your company has, you should consider making early repayments wherever possible. Doing so could save you a considerable amount of money in the long run and also improve your business credit score. Remember to check whether any early repayment penalties apply.
2. Grow your business
If you have plans to grow your business in the future, you could put your company’s surplus cash to good use by reinvesting it back into the business. There are several ways you can do this, for example:
- opening additional premises in new locations
- start exporting
- improving your existing products and services
- expanding or diversifying your range of products and services
- buying new equipment and machinery
- hiring more staff
- moving to larger premises to increase capacity
- providing training and development opportunities to key employees
- funding a new acquisition or setting up a new business
- improving your marketing strategy
Your company will be able to claim tax relief or capital allowances on most types of expenditure incurred in the course of growing the business.
3. Invest in research and development
Depending on the industry you operate in and the types of business activities you carry out, it may be beneficial to invest surplus cash in research and development (R&D). This could be a great way to develop your products or services and improve processes and technologies.
An effective R&D strategy is one of the best ways to stay ahead of the competition and build a more resilient and profitable business. You may also be eligible to claim Corporation Tax relief on your Research and Development project.
4. Issue dividends
It’s not uncommon for new company owners to avoid taking dividends in the early stages, opting instead to leave profits in the business as a buffer. This is sensible, but it is not always the most tax-efficient approach.
Provided there are sufficient retained earnings, issuing dividends to yourself (and other shareholders, where applicable) in each tax year may be the better choice. You can take dividends in addition to, or instead of, paying yourself a director’s salary.
In the 2023/24 tax year, there is a tax-free dividend allowance of £1,000 (reducing to £500 in 2024/25). Your first £12,570 of income is also tax-free, regardless of whether this comes from salary or dividend payments.
Depending on your total taxable income for the year, you will then pay dividend tax according to your Income Tax band. This means that you will pay 8.75% tax on dividends if your annual earnings are between £12,571 and £50,270. However, if you are a higher-rate or additional-rate taxpayer, your dividend income will be taxed at 33.75% and 39.35%, respectively.
Where company finances allow, it’s generally advisable to pay yourself at least up to the basic rate threshold each year. And since dividends are subject to lower rates than salary income, it’s better to take the bulk of your annual earnings as dividend payments.
5. Pay into a pension
Whether retirement is on the horizon or a long way off, paying into a pension through your limited company is one of the most tax-efficient ways to extract money from your business and utilise surplus cash.
By making contributions directly from the company, the payments are treated as a business expense, meaning they are eligible for full Corporation Tax relief in the financial year they are paid.
And unlike personal contributions that come directly from your salary, pension payments from the company are not subject to National Insurance. Additionally, there is no limit to how much the company can contribute to your pension tax-free.
6. Buy commercial premises
If you currently rent commercial premises, you could consider putting your surplus cash toward the purchase of a suitable commercial property instead. Whilst not feasible for many small businesses, it may be worth thinking about if you are in a position to do so.
On a smaller scale, you could use extra money to invest in new plant and machinery assets for the business, either to replace less efficient items that the company owns or leases.
7. Carry out a buyback of shares
Carrying out a share buyback may be beneficial if your company has multiple shareholders and/or too many issued shares. By doing so, the remaining shares will become more valuable.
Using surplus cash for this purpose may be more tax-efficient than paying dividends on those shares. However, it depends on various factors and can be incredibly complex, so expert advice should always be taken first.
8. Make charitable donations
For an increasing number of businesses, gifting to charity wherever possible is an integral part of their ethos and Corporation Social Responsibility policy.
Aside from the benefits this can provide to the organisations or communities you support, your limited company will enjoy tax relief on the charitable donations it makes.
Putting your surplus cash to such use and publicly expressing your support can also help you to attract consciously-minded consumers and highlight the causes that you are most passionate about.
9. Invest in stocks and shares
Investing in stocks and shares can be a risky business, which is why it’s advisable to do so using only surplus cash. Corporate investing can be a good way to earn additional income for your company, perhaps to fund its growth or purchase new equipment.
However, it’s usually more tax-efficient to make investments from personal funds, rather than through your limited company. As an individual, you will be entitled to the Capital Gains Tax allowance of £6,000 (2023/24 tax year) on any profits you make when you sell or dispose of your investments.
10. Place in a high-interest savings account
A final option is to simply transfer your company’s surplus cash to high-interest business savings accounts. You can usually secure more favourable interest rates by locking in the money for a fixed period. This may be ideal if you have no immediate plans to use the money.
Thanks for reading
Having surplus cash in your limited company is a positive sign (unless it’s only there because you’ve forgotten to pay a massive tax bill). However, leaving this extra money in the business is rarely the best decision and may even lead to problems in the future. There are far better ways to use it, many of which could lead to more profits.
How you manage this surplus will depend on your business objectives and personal circumstances. To explore the various options available to you, speak to an accountant or financial advisor for expert guidance. By taking professional advice, you can make informed decisions on how to utilise this money in the most appropriate and tax-efficient manner.
Please comment below if you have any questions about this post, or contact us if you would like to speak to someone about our company formation services.