Business StrategyCorporate AdvisoryGeneral Business

Navigating the Financial Challenges of Business Growth

As a business owner, watching your company grow is incredibly rewarding. However, growth brings its own set of challenges, particularly when it comes to business funding. No matter how well cash flows, there are times when it simply isn’t enough to support expansion.

In this article you will learn:

  • How to identify, anticipate, and plan for the need for funding.
  • Sources of funding — Equity, Debt, Asset, Government Grants, and the Retention and Reinvestment of Profits.
  • Pros and cons of each method.
  • CapEx (Capital expenditures) and Working Capital

The first step in managing growth is recognising when, where and why you’ll need extra funds. Growth often demands more people, more space, and/or more machinery (if you’re a manufacturer). That translates to significant capital expenditure (CapEx) and increases to Working Capital.

So, where will growth be felt in your business and what are the things that could cap your growth?

A good way to go about answering this is to conduct a ‘walk-through’. To illustrate – a table manufacturer might follow a basic input like a nut, all the way from procurement to its eventual sale, to collection of the cash from that sale and reconciliation of accounts receivable.

As you follow that nut through your business, you will notice things like – you need more money to buy more nuts; it’s no good having lots of nuts if you don’t have any timber and glue to make more tables, so you need more money for that; you need somewhere to store the nuts, timber and glue until they go into production so you may need more racking; you will have more forklift movements so you may need another forklift; a forklift needs a driver and so on.

If you have built a financial model for your business, congratulations. You will have already uncovered the financial interdependencies that exist within your business, such as those in the example above, and you will be well on your way to understanding how growth will impact your funding needs.

Learn more about how Financial Modelling can help you with it. Moreover, you will have a great chance of sustaining that growth over the long term.

Anticipating financial requirements involves understanding the scale and timing of your needs. Create detailed financial forecasts that account for both best-case and worst-case scenarios. This allows you to gauge the potential gaps in funding and prepare accordingly. For instance, if your business is seasonal, you might need more working capital to handle peak periods. Similarly, if you’re launching a new product, upfront costs may be so significant as to necessitate external funding.

Once you’ve identified and anticipated your funding needs, it’s crucial to plan how to meet them. Here are the three main sources of funding to consider:

1. Equity Funding

Equity financing involves giving up ownership in exchange for an injection of capital. This can be a good long-term solution and is a way to raise growth funds without incurring debt. The value of the shares/other and the amount of equity to be offered depend on the company’s valuation, which can be determined through various methods. However, it comes with the downside of diluting your ownership and possibly losing some control over the business. Equity investors often seek high returns and may pressure the business to prioritise short-term gains over long-term stability.

However, unless the capital comes from the same owners and in the same proportions, it comes with the downside of diluting your ownership and possibly losing some control over the business.

Consider also that some equity investors may have differing objectives – some may seek higher near-term returns and may therefore seek to pressure the business to prioritise short-term gains over long-term stability, so it’s important to make sure all owners are ‘on the same page’ and always have a well-crafted, fitting shareholders’ agreement prepared by an experienced commercial lawyer.

2. Debt Financing

Debt financing includes things like loans, hire purchases, finance leases and lines of credit. This method allows you to retain full ownership of your company, as lenders don’t acquire equity. The primary downside is the obligation to repay the loan with interest, across an agreed period of time, which can strain cash flow. Securing a loan can also be challenging for businesses without a strong credit history or substantial assets.

Let’s say you are a manufacturing company that takes out a business loan to purchase new machinery. While this increases production capacity, your projections must tell you that you will now generate enough revenue to cover your variable costs and the loan repayments on the terms agreed. The pressure then comes on to actually deliver on your projections.

Click here to learn how to get your bank funding across the line.

It also pays to beware of lender’s covenants. A minimum profit target, for example, may mean that you delay an expenditure decision, the benefits of which will be enjoyed in a later year, simply to ‘prop up’ this year’s numbers. Therefore, understand that debt comes with the loss of certain freedoms to make decisions as you see fit, in a world that can change in the blink of an eye.

3. Asset Financing

Asset financing allows businesses to obtain growth funds by using their existing or newly acquired assets, such as equipment, inventory, or receivables, as collateral. This can be an effective way to secure capital without giving up equity or giving wide-ranging security such as those under a ‘General Security Agreement’.

In the case of newly acquired assets, asset financing can be a good way to match the future benefits (cash inflows) expected from purchasing the asset against the cash outflows needed to pay it off. Similarly, it can be used to release cash from assets you already own. The downside is that failure to repay the loan could result in the loss of critical business assets.

4. Government Grants & Incentives

We love Government Grants and Incentives because they are an immediate injection of capital that, in most instances, never attracts interest and never needs to be repaid. They act like an injection of non-dilutionary equity by the existing owners, in the existing proportions of ownership. So, if you are eligible for such grants and incentives, you would be crazy to miss out.

5. Reinvestment of Profits

Reinvesting profits involves using your business’s earnings to fund growth. This approach avoids taking on more debt and it doesn’t dilute ownership. So, it seems to be all good provided for the time being that the shareholders’ are more focused on growing the value of their shares than they are on dividends (we assume a company structure here, since certain other structures like trusts may not be able to tax-effectively retain profits).

However, it requires your business to be profitable, and to accumulate cash, and it may slow down growth compared to external funding methods that will give an almost immediate injection of capital. It’s also true that profits can fluctuate from period to period and that makes planning self-funded growth difficult.

Imagine you own a small retail business that has been constantly growing over the past few years and you’re looking to expand by opening a second location. Instead of taking the profits out as personal income or distributing it among shareholders, you decide to reinvest it back into the business. This decision is based on the belief that expanding your physical presence will lead to greater long-term profits. While reinvesting profits can signal a healthy and organic growth, it also means your grow is limited by the amount of profit generated.

As your business grows, balancing capital expenditure and working capital is critical. CapEx involves long-term investments in physical assets like buildings and equipment, while working capital covers day-to-day operational costs. Both are essential, but they serve different purposes.

Therefore, it’s crucial to allocate funds strategically. For instance, investing heavily in CapEx without sufficient working capital can lead to cash flow problems, even if your assets are growing. Conversely, focusing only on Working Capital might hamper your ability to scale up operations.

A good example is the company LMN Pty Ltd (fictional name). They have just won a new contract to supply springs to a company that builds rifles for the Australian Defence Force. LMN has identified the following Capital Expenditure to become production ready:

  • New plant and equipment – $380,000
  • Factory extensions – $400,000
  • Factory reconfiguration – $230,000
  • Used forklift – $22,000
  • Racking – $40,000
  • Contingency – $128,000
  • Total CapEx – $1,200,000

LMN has also identified the following increases in Working Capital required:

  • Raw materials – 14 days – $90,000
  • Conversion costs (ex-labour) – 3 days – $20,000
  • Labour – 4 heads – 55 days – $55,000
  • Contingency – $20,000
  • Total Working Capital – $185,000

In the example above, LMN needs to find $1,385,000 of funding in order to achieve the growth that they are so desirous of. That might come from existing cash resources (if an excess exists), loans, asset finance, an injection of equity or some combination of the above.

Navigating the financial challenges of business growth requires careful planning and strategic decision-making. And regardless of how well your business’ cash flows, ensuring you have enough of it at the right times is key to sustaining growth.

If you’re ambitious business owners that want to grow, let’s have a coffee. Having the right advice can guarantee you’ll be well-equipped to manage the exciting challenges of growing your business.

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Neil Parker
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