How much can I safely take out of my company?

It's the question every owner of a profitable business asks, usually at the worst possible moment: just after a good month, looking at a healthy bank balance. And the usual answer is a guess.

The bank balance is the wrong place to start. Most of the money in a business account is already spoken for:

• wages for the next pay run;
• GST and PAYG collected for the ATO;
• super due at the end of the quarter;
• supplier bills that haven't landed yet;
• tax on this year's profit.

Take those out and the "spare" money is often a fraction of what the balance suggests.

Profit isn't cash, and cash isn't surplus

Two things trip owners up.

A profitable quarter can finish with the cash still in debtors. If customers pay at 45 days, the profit from the last six weeks is a receivable, not money in the bank.

Cash in the bank isn't all yours to take. Some of it is the business's working capital: the float that pays this month's costs while next month's revenue comes in. Take that out and the business has to borrow it back, or stretch suppliers, the next time a big customer pays late.

Start with a buffer, then look at what's left

The cleaner way to answer the question has two steps.

1. Decide how much cash the business must always keep. A common way to set it is a multiple of a typical month's costs, smoothed over a few months so one big month doesn't distort it. This is the working-capital buffer.
2. Only what sits above the buffer is in play. Even that is worth testing against how the business is actually trading: if revenue is falling behind plan, a payout now can leave the business short later.

Written down and agreed by the directors, those two steps become a working-capital policy and a dividend policy. With them on paper, the answer stops depending on who asks, or how the bank balance happens to look that day.

What a written policy changes

• The answer is the same every quarter. You run the same test on your closed numbers and read the answer off, rather than debating it.
• You can say no without a fight. "The policy says the buffer isn't covered this quarter" is easier between business partners than "I don't think we should."
• Lenders and investors take it seriously. A business with a cash buffer it actually keeps is a better credit risk.

Where the line sits

Working out what the business can afford to pay out is a finance question. How you pay it (as a dividend, salary or drawings), and the franking and tax that come with it, is a tax question for your tax agent. Keep the two separate and you'll get a better answer to both.

General information only, not tax, legal or financial product advice. Your registered tax or BAS agent handles tax and your activity statements.

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Keep reading

• A budget nobody reports against is just a guess
• Why your business needs a cash buffer, and how big
• Will you have enough cash in eight weeks' time?
• Is your month actually closed?
• Have you outgrown a year-end-only accountant?
• Profitable, but no cash: where it goes
• All guides and articles