In more difficult economic times, cash management within a company can be a strategic element that differentiates between those who stand out, those who survive and those who disappear. Let us remember the shock of the almost complete shutdown of the economy in March 2020: we were then able to observe that many companies — as well as several individuals — were not prepared for such crisis management.
Admittedly, the situation at the time was so surreal that no entrepreneur could possibly have planned it. This is precisely why it perfectly illustrates the importance of holding cash. Several resources exist to help business owners establish a cash budget and an accurate cash flow. Planning “working capital” should be done proactively, when business is good. This sometimes involves increasing liquidity, as well as negotiating lines of credit that make capital available for the operation of the business.
More than two years into the pandemic, it’s possible to observe an interesting phenomenon: many companies are now overcrowded, having taken advantage of generous (and let’s face it, lengthy) relief packages to companies offered by governments! Few dare to talk about it, but we all know people, individuals and corporations, who have, so to speak, enriched themselves during the pandemic… There are also entrepreneurs who have always been the “squirrel” type. They accumulate far too much cash for contingencies that ultimately never happen. “Too much is like not enough,” my mom used to say.
Too much is like not enough
Balance, as with everything, is hard to find in corporate bank accounts. Between insufficient liquidity and weakness in times of crisis. Between too abundant liquidity and potentially less enrichment for the shareholder. Indeed, the first danger that lurks for many entrepreneurs, in my experience, is the temptation to always put the business before their personal goals. Over the years, a business owner who constantly uses his company’s cash as leverage for corporate investment may find himself dependent on the sale of his company to achieve his retirement goals. The entrepreneurial nature leads to audacity, I understand that!
Moreover, many entrepreneurs accumulate cash in the business by telling themselves that they will never sell it. However, should the opportunity arise unexpectedly, holding too much capital in the business will adversely affect the taxation of the transaction. Indeed, in order to take advantage of the capital gains exemption, the shares of the company must meet certain criteria, one of which concerns the use of the assets during the 24 months preceding the sale.
Specifically, more than 50% of the fair market value of the shares must be actively used in the operation of the business throughout this period. Too much liquidity could therefore affect this test. This would be the case, for example, for a service company holding little inventory or other assets used in its operations.
Pay yourself first
It is inadvisable to improvise yourself as a tax expert, as the tax law is very complex. With the advice of an expert, you will be able to determine the relevance of carrying out a “purification” of your company in view of a possible sale of the shares. Whether through a tax reorganization or other decisions aimed at distributing dividends in an optimized way to shareholders, you can manage to keep only the cash required for the proper functioning of the company, in collaboration with your team. financial specialists (accountant, financial planner and even your creditors!).
For example, do you have a balance in the capital dividend account (CDA) allowing an amount to be transferred to you without personal taxation? Should you use a holding company to invest in a stock and/or real estate portfolio rather than personally? Have you considered the creation of an individual pension plan (IRP) in the company to reduce liquidity? Finally, in the context of rising rates, even the cash to be kept should be in a high interest account. Paying yourself first should be the entrepreneur’s first motto.