Planning for Business Expansion
A growing firm often finds it necessary to expand the level of its operations. To accomplish this, the firm might acquire additional fixed assets, such as property, a plant, and equipment. Often, an expanding business will require additional personnel. In some cases, a business will expand so much that buying another existing business or franchising its own business might be desirable options.
Planning for business expansion includes anticipating the need for expansion, analyzing the appropriateness of a capital expenditure or a loan, securing appropriate financing in a timely fashion, and implementing the plan. Effective planning also involves an analysis of your current assets, debts, and profit levels as well as a projection of the necessary assets, debts, and profit potential of your expanded business.
Tip: The tax code provides incentives to business owners to expand their businesses. Section 179 of the tax code allows businesses to deduct immediately the full cost of qualifying machinery and equipment, subject to an annual limit ($25,000 in 2014; note that equipment purchases exceeding $200,000 will reduce the amount of the allowable deduction).
Why expand your business?
An expanding business offers the potential for numerous growth opportunities. Employees benefit from business growth through increased earnings and promotions. Customers benefit from expanded products and services. Owners benefit through increased profit potential. When sales and profits increase dramatically, expansion is often necessary to meet demand (i.e., to ensure that existing orders are filled promptly and that new orders can be accommodated).
How do you manage the growth of a business?
The financial and operational aspects of growth must be balanced when you expand your business. During a growth phase, for example, the marketing function of the business may extend beyond the business’s financial capacity to sustain growth. There are many factors you should keep in mind when managing the growth of a business. In general, you should expand only if your business is already profitable. It makes little sense to incur additional debt when your cash flow is poor. Furthermore, profitability makes it easier to obtain the financing necessary for expansion.
Make sure that the management skills and abilities match the increasing demands of a growing business. In addition, you should probably seek assistance from professional advisors familiar with the unique needs of growing businesses. As for personal concerns, bear in mind that expansion of your business will necessitate greater personal involvement and commitment on your part for a time. Cash flow management is also absolutely essential to the growth of a business. In general, a cash flow analysis shows whether your daily operations have generated enough cash to meet your obligations, and whether you periodically end up with a positive sum of cash on hand or with a net drain of cash. It is important to have enough cash on hand each month to pay the cash obligations of the following month. Cash flow deficiencies indicate a need to alter plans to provide more cash. Excessive cash surpluses, however, may indicate excessive borrowing or idle money that could be invested in your own business or elsewhere. There are a number of techniques for increasing the inflow of cash and decreasing the outflow of cash.
In what ways can you expand your business?
There are many ways to expand your business. For instance, you can move to larger offices or obtain additional property and plants, purchase new machinery and equipment, hire additional personnel, increase marketing and advertising efforts, purchase other existing businesses, or perhaps engage in franchising.
When your business expands, you may find it more cost-effective to “outsource” certain business activities, such as your bill collections. In some cases, outsourcing might help to improve the operational efficiency of your business.
How can you obtain capital for financing the expansion of your business?
To obtain bank financing for your business, you need to understand the bank’s concerns. To avoid risky investments, bankers primarily base their loan decisions on the collateral and equity position of your company, as well as your cash flow, profitability, and management ability. Bear in mind that because banks want security (collateral) in case you default on your loan, it is often easier to borrow money to buy fixed assets (such as inventory, equipment, and buildings) than it is to borrow money for marketing expenses or general operating costs.
When considering a loan application, banks typically review the current and projected equity position of a business. Equity is what’s left after you subtract all liabilities from all assets. Ways to bring equity into a business include the following:
- Venture capital funds
- State and federal financing programs
- Private investments
- Owner’s personal investment in the business
When submitting a loan application, banks will require a formal business plan that includes detailed financial statements and business projections.
Tip: Other sources of financing exist as well. These include the Small Business Administration Loan Guarantee Program, various state financial programs for business owners, and venture capital funds.
How do you estimate the costs of expansion?
An important part of growth is the budget, or the allocation of funds to those activities that will bring about growth. Because you need to borrow the right amount of money (neither too much nor too little), it is vital that you estimate the costs of expansion accurately.
For instance, to properly estimate the cost of a building, you should have a blueprint created and request bids from contractors. Discuss how subcontractors will be managed and paid. Also, make sure that scheduling of the work is made clear so that the project will be completed in a timely fashion.
In terms of the cost of purchasing new equipment, you should contact several equipment suppliers to discuss your needs and their prices. Also, ask about the cost and timing of delivery and installation. Think about leasing as an alternative to purchasing equipment. In general, when considering expansion, you’ll need to project the additional cash needed to support your increased activities. The best method for calculating this additional amount is to use a cash flow projection. After determining cash needs, set aside a certain amount to cover unexpected liabilities or unforeseen problems.
What about purchasing another business or franchising your own business?
At times, expansion can be accomplished by purchasing another business. In such a case, the expansion costs equal the costs of purchasing the business plus the amount of money needed for improvements and operating expenses. Many industries have standard rules on how to determine the purchase price of a business. The advantages of buying an existing business include the following:
- Established product or service
- Established “goodwill”
- Management team in place
- Existing collateral
- Reduced start-up time and cost
Sometimes franchising is an option. Franchising may be defined as the contractual method for marketing and distributing the goods and services of a company through a restricted network of distributors. Typically, a franchisee purchases the right to operate a single outlet at either a specified site or within a specified region. The franchise agreement generally requires the franchisee to pay an initial franchise fee for the right to use your trademark and business system. In addition, the franchisee typically also pays an ongoing percentage fee or must buy products or services from you. Detailed discussion of franchising your own business is beyond the scope of this discussion. For more information, consult additional resources.