Is your limited company suffering from cash drag?

It is not uncommon for limited companies to build up sizeable cash balances. Most owners opt for a low salary, high dividend and regular employer pension contribution type strategy. But what about companies in the fortunate position of being able to accommodate this and still have large cash balances?  

A route most take is the ‘path of least resistance’ i.e. leaving it all in the company bank account. This is by far the easiest option and arguably the safest. The main drawback of this is that interest rates are currently very low and have been for many years now. When you factor in inflation you may be in a position of losing money in ‘real’ terms. The chart below aims to illustrate this: 

Assumptions used:

Initial investment amount £1,000,000

Long term cash return: 1.5% per annum

Long term inflation rate: 2% per annum

Long term investment return: 5% per annum

You can clearly see the issue of holding cash that is consistently generating a return that is less than the rate of inflation.

 

What can business owners in this position do?

  • Nothing. Just accept that your cash is slowly reducing in real terms.

  • Try and find a better rate of interest. This is tricky at the minute unless you want to tie up your cash for several years at a time.

  • Extract more via salary/dividends/pension contributions. The main issue with this is the increase in tax when withdrawing from the business.

  • Look at setting up a general investment account within the business This will allow the cash the opportunity to hopefully generates returns in excess of the inflation As with any investment, the risk associated means that the underlying investments will go up and down. Discussions would need to be had with your accountant regarding the potential tax implications of this route.

When used in the right circumstances, option four can be a very attractive route for many business owners.

There is no one size fits all approach and individual advice should always be taken. This article is for information purposes only and should not be taken as advice.

Ashton Chritchlow