Most small business owners hope to, or plan to, grow. When you open one café you may have dreams of a nationwide chain. The first product you use to launch your manufacturing business could be one of many designs you have mapped out.
But how do you know when it’s actually time to open that second café? Or start ordering the supplies to make that new product? Actually taking that step can be nerve wracking, but knowing what signs to look for and how to prepare for growth can make the growth process a lot less scary.
What are the Signs it’s Time to Grow?
You may want to grow, but how can you when if it’s the time to grow? Often, your business will give you clues.
Pay attention to your customer requests. Are they requesting more services, or asking for different products? These could be signs pointing you to potential growth areas. If customers are willing to wait for your services, or to work with you, and you have a wait list then you should consider expansion.
Another sign is when your industry is growing. When there is interest, and capital, pouring into your industry now could be the time to seize the opportunities that interest represents. Opportunities may be coming your way, such as another company reaching out and asking you to partner with them, or a customer bringing you a design idea for development, and if you say “no” you could miss out on the chance to grow.
Take a look around your warehouse or office. Are you running out of room? If your employees are bumping elbows at their desks and product is stacked up on the floor and between shelves it could be time to expand.
If your business is profitable, and you have excess capital, you could be searching for a place to invest your profits. Investing in growth can be a smart move, particularly if that growth would help shield you from economic downturns in the future.
Planning for an Effective Expansion
There can be a lot of moving parts involved in a business expansion. Without a clear plan in place costs can spiral out of control, you could run out of financing, or the expansion could take longer than expected and hurt your cash flows.
If you didn’t create a business plan when you first launched your business, or you haven’t revisited it in a while, now is the time to create one. A business plan provides the guide to inform growth decisions. When looking at an old business plan you may realize that, while you’d planned that one product would only generate 20% of your revenues, it has actually turned into your money maker. You may need to adjust your plan. Plans shift, and no more so than when a business is first starting up.
Revise an older business plan based upon your business’ current situation. If you need help analyzing your numbers and profit margins, reach out to your accountant or finance professional. Once you have a good grasp on your current state, look at where you want to grow. How much would it cost to add additional dining space to your restaurant, and how long would it take to build it? What about research and development of a new product?
Gather estimates as needed, consult experts, and make sure that you have a very good grasp of where you want your business to be after the expansion and what it will cost before you begin.
Should you Borrow to Grow?
It can be difficult for a business to generate the capital they need to fund an expansion through existing revenues. Acquiring a new piece of equipment or paying a contractor to renovate requires a significant sum of capital. Even if you could set aside some money each month from your business’ revenues by the time you have saved enough the growth opportunity could have passed.
It is the rare business that doesn’t need to borrow capital at some point in their history. Borrowing is one of the easiest ways to have access to a large sum of capital to help your business scale up. When deciding whether or not to borrow you should look at your expected rate of return and rate of return.
The expected rate of return is the amount of profit or revenues you expect your spending to generate. You can calculate it by multiplying potential revenues by their chances of occurring and then summing them.
Let’s say that you think there is a 50% chance that your investment will generate 20% more revenue for your business and a 75% chance that it will generate 30% more revenue. Between these two possible outcomes you’d have an expected rate of return of 40%. As an equation it would be (50%*20% + 75%*30%) = 40%.
How does this help you when deciding whether or not to borrow? It will tell you if an investment has a positive or negative average net income and it will help you when evaluating different opportunities. If adding a new product would generate an expected rate of return of 30% but adding a different product would generate 55%, you know where to invest your money.
The rate of return is slightly different. It measures the profit on an investment, and in this case the investment would be money you’re borrowing. Rate of return is calculated by taking you’re the final amount of revenues or profit you expect your investment to generate and subtracting your initial profit, then dividing by the initial profit.
As an example, let’s say your restaurant generates $20,000 a month in net income. After adding seating you’ve projected it will generate an additional $15,000 of net income and you plan on borrowing $20,000 to fund this expansion. Take the final value of $15,000, subtract $20,000 and divide by $20,000 and you’ll have a negative 25% rate of return.
However, you should calculate this rate of return over time to get a true rate of return after you’ve had that additional seating for a year. These calculations can get complex but you can use an online calculator or ask your accountant to help you with them.
A genera rule of thumb is that the expected return on an investment should always return more than what you paid to borrow. If the rate of return is lower than the interest rate you will pay on the loan you shouldn’t borrow. Would you pay $10 for a part which will only generate $5 of revenue? No, so don’t do essentially the same when borrowing to fund an expansion.
Managing Cash Flow during Expansion
Managing cash flow during an expansion phase is crucial to success. There is typically a gap between when you have to fund the expansion efforts and when they will generate revenues for your business.
If you borrowed to fund your expansion, or are using funds set aside from your revenues, pay careful attention to your budget. Track expansion-related spending to make sure that you don’t exceed your budget and are, in fact, using borrowed funds for their intended purpose. Going over-budget could not only jeopardize the project it could harm your existing business.
If you exceed your budget you may have to borrow more. This, in turn, could change your expected profitability and rates of return. If you decide instead to divert money from your business’ revenues you might not be to able existing bills.
If you already know that you struggle with cash flow management, try the trick of opening a separate checking account for borrowed or ear-marked funds for the growth phase. Pay all of the expansion-related invoices and salaries from that checking account, and don’t mingle those funds with those used in day-to-day operations.
How you plan for growth or respond to unexpected growth can have a big impact on your business’ trajectory. Follow these tips and consult with professionals to maximize your odds of success.