In a previous blog on cash reserves, I covered why it’s unwise to let large amounts of cash sit in your practice. Now, I want to expand on the reasons why it’s important to intentionally and regularly distribute excess cash.
If you need a refresher on how to calculate a reasonable cash reserve, make sure to read that earlier blog post. In general, any funds over the reserve target (evaluated quarterly or semi-annually) can be considered excess cash. This applies to your operating account, separate from any tax reserves or other designated funds (like a 401k match or planned large expenses).
With that in mind, here are four reasons you should move excess cash out of your practice.
1. In most practices, you’ve already paid taxes on the profits that become excess cash.
Most practices are pass-through entities, which means the corporate profits “pass through” to your personal income return.
There are reasons that profits don’t turn into cash flow. They can be used for debt payments, reinvested in the practice, used to pay taxes, or set aside to build up cash reserves. Regardless of how you spend your profits, your tax bill is based on profits, not distributions.
The excess cash that’s left in your checking account isn’t going to be taxed when you distribute it (except if your practice is a C-Corp!). It’s already been taxed. Why not take a distribution?
2. There are better vehicles for saving cash.
This is less true today with higher interest rates for checking and money market accounts. But given the high inflation we’ve been experiencing, investing your cash in higher-return asset classes (including investing back into your practice) is generally a better way to preserve and grow the value of your dollars.
Leaving cash untouched may feel safe, but inflation ensures it’s quietly shrinking in value.
3. If you’re incorporated, taking distributions protects your cash in the event of a lawsuit.
Malpractice lawsuits and other claims are incredibly rare in the optometry space. All the same, the risk of your practice’s assets (including cash) being exposed to some loss is not zero.
By moving excess cash out of the business, you’re making full use of the liability protection your corporate structure is designed to offer you and your family.
4. Getting cash out of your practice disciplines practice investment decisions.
When there’s a large cash cushion, it’s easy to justify big-ticket purchases, like that $90,000 IPL you’ve been eyeing, even if you’re unsure how much demand exists.
You’re not sure how many of your patients will go for $1,600 worth of treatments, but you’ve also got $250,000 in excess cash that’s burning a hole in your pocket.
That decision requires more thought and scrutiny if your entire cash reserve is a (let’s assume) healthy and appropriate $90,000. Taking regular distributions can prevent impulse spending and promote strategic thinking.
NOTE: Don’t miss the inverse of this situation, though. If you’ve done the homework and know the investment makes sense, then it’s smart to build up cash intentionally for that purpose.
What if your financial statements gave you clear guidance?
One of the things I’m most proud of at Books & Benchmarks is how we’ve designed our reports to help practice owners clearly connect the dots between profits, cash flow, and cash reserves. If you’d like your cash reserve target calculated automatically for your office so you know how much you can take in distributions, give us a call!
It would be a privilege to produce financial statements for your practice that are accurate, timely, and meaningful to how you run your business. Contact us today to get started.
