When your business experiences unexpected growth, most owners would turn to their bank for additional working capital, but what should they prepare for when seeking finance?
One of the biggest impediments to a growing business is not having sufficient cash in the business to ensure it can continue to do business as usual and scale at the same time. It's a situation that can become particularly acute when unplanned growth occurs.
It's no secret that that biggest secret for start-up and growing business success is having the right funding in place at the right time. As activity within the business increases to accommodate new sales opportunities, cash flow within the business will need to allow for increased spending, lags in sales revenue being realised and investment in resources to deliver the new business.
It's a juggling act that often impacts small business owners in unexpected ways. Business owners understand that revenue can fluctuate but usually have working capital in place to accommodate what constitutes "normal" business. As the business starts to grow, it can get difficult to ensure that there is sufficient cash flow to match the increase in activity.
Let's look at a typical example:
Jonathon runs a typical small business. Since taking over the established business a year ago growth has accelerated. The primary product of the business is brought in from overseas. The business is predicated on a budgeted turnover of $70,000 - $100,000 per month. The working capital in place accommodates the business operating at this level which is already a step up from where it was when he bought it.
Jonathon knows the business has a lot of potential and he's been working hard to fulfil its promise. He's ecstatic because he's brought in five major sales all within the $50,000 - $200,000 range and all expect delivery within the coming 3 months. While the big sales required a dip in the gross profit margin, it's still doable.
If all of the orders come through, the impact of the new sales will take his turnover from its current level of $100,000 per month to an average of $250,000 per month for the next 3 or 4 months. If you imagine yourself in Jonathon's place, it would be hard not to be impressed with your efforts wouldn't it? What a boost to the company.
Now add in another factor. The primary product is purchased from the supplier without trading terms so the outlay for any major sale is in advance. As a result, the cash flow implications of the time between each sale, the purchase of the product from the supplier, fulfilment and payment by the customer is critical to understand. For Jonathon, the highest risk is the major outlay of cash required to fulfil the sale. He cannot buy time.
When Jonathon had a cash flow analysis put in place to determine the impact of the new sales it revealed that he needed $200,000 to $300,000 more cash than he had. He knew it might be tight but didn't realise the situation was that stark. As a result of the analysis, Jonathon was able to work with the customers to stage the orders and manage the cash flow requirements.
Had he fulfilled the sales without the analysis, he would have had a funding gap of approximately 60 days where he was exposed by $250,000 without the capital base to support him.
How can you fund growth?
It's too late to talk to the bank if a cash flow issue has already presented itself – more often than not, the bank will recognise the business risk and reject the funding request.
In the example above, cash flow was the major issue. In others it is profit. Large customers with large orders may expect you to cut your margin, request discounts to increase the order or play hardball on payment cycles.
The danger is that you, or your sales people, get carried away with the headline number and don't look at the profit contribution. Some sales, even big sales are simply not worth it as you can't trade below a certain profit level. For businesses with higher fixed costs your ability to negotiate your margin is less flexible than those with higher variable costs. The key is to know your break-even point before entering into any deals.
And, discounting can be its own trap. For example, if your margin is 40 percent and you reduce your price by 10 percent, you need a 33 per cent increase in sales volume just to maintain your profit level.
The best way to ensure your business can cope with the increases in sales and costs that come with business growth it to talk to your advisors, who can help you understand the numbers of your business and ensure that you understand the impacts on your cash flow.
Advisors such as accountants and finance brokers offer valuable support in ensuring that you have the appropriate finance facilities in place to grow your business. Your advisory team will help you to approach potential financiers with the key things needed to put the best foot forward:
- Accurate financials
- A clear explanation of how the business works
- Accurate forecasts that show how the lender will be repaid and what variables may arise
There are few guarantees with bank lending, however working with your team to understand the numbers in your business is a vital part of putting the best foot forward.
However, it is not without risk or issues. Many types of finance, e.g. debtor finance, can be expensive to administer and a potential trap; correctly managed, trade finance can be a great way of dealing with large growth spurts.
There's no question that a strategic finance plan with alternative facilities such as overdrafts, term loans and other types of finance will help business sustainability through a growth period, however these are often difficult to secure without putting other assets up as security.
The imperative is to ensure that whoever you approach for finance can easily see and be confident in the financial direction of the business.
This article is provided for information purposes only and correct at the time of publication. It should not be used in place of advice from your accountant. Please contact us on 02 9957 4033 to discuss your specific circumstances.