Before embarking on expansion consider your cash flow
Expanding a business at anytime has its risks, but in the current climate of financial uncertainty it’s particularly fraught. If your company is thinking of growing and moving into new markets then there are key risks you need mitigate if you want to increase your chances of success. At the latest FD Recruit – FD & CFO Conference some of the UK’s most successful finance directors shared their expertise on why managing cash flow is the priority.
The success of expansion plans relies on your company’s ability to maintain the right balance within the working capital cycle. Before embarking on growth, you have to establish if there’s enough cash available to adequately cover the costs of expansion. You also need to understand all the development expenses involved in setting up in a new market and know what your exposure is likely to be.
A cash flow forecast is critical, proper planning will enable you to make an educated guess as to the working capital required. It’s often said that a lack of profit is a slow and painful way to go broke, but a lack of cash will be very fast and even more painful.
There are five main causes of cash flow problems when expanding a business.
Sales growth is too slow to cover the increase in overheads
Growing companies can experience negative cash flow when fixed costs such as labour, rent, leases and marketing exceed income. It’s important to know how your company will finance these additional costs prior to initiating expansion. Have a business plan to understand the short-term and long-term effects of the expansion. Look at the potential best and worst case scenarios for your cash flow, but bear in mind expenses are usually always higher than anticipated and revenue from new markets almost always occurs more slowly.
Even if you are able to generate a lot of new sales it could still use up too much working capital while you’re waiting for customers to make payments. Despite potential profitability if you haven’t got the cash or if you can’t get funding from the bank then trying to fulfil orders could be difficult,
Too much cash tied up in accounts receivables
It’s almost inevitable that as your turnover grows so will your debtors. It’s usually a linear progression, if you’re turning over twice as much then your accounts receivables will double too. It’s important to implement credit control procedures from the start. When moving into new markets you will be taking on new customers, so take steps to carryout adequate credit checks and don’t extend generous credit terms too quickly. It may be prudent to invest in credit insurance although many providers have become risk averse in recent years, however if a UK insurer will not cover you then an overseas company may.
Stock levels grow & absorb too much cash
As the business attempts to expand it will need additional stock to allow for increasing sales. But while you’re in the process of developing new customer relationships stock may move slowly. Unsold stock is a serious risk to every business if it’s allowed to just sit in a warehouse, it can leave your company strapped for cash. Rigorous inventory forecasting processes can help you predict the likely amount of stock needed to meet demand.
If the company finds itself struggling to meet supplier payments then try negotiating the terms of trade. As little as seven days extension can alleviate overdraft facilities or make the difference between a business needing and not needing bank funding.
Working capital is used up on financing fixed assets
Fixed assets are hard to turn back into cash, so overinvesting in property, plant or equipment can limit working capital. The problem can be made worse if short-term finance solutions such as overdrafts are used. Look at all available financing options to find one that will give you the best deal without restricting your cash flow.
Not enough research before venturing into foreign markets
Simply selling more of the same to similar customers is the safest or least risk option when expanding. If you decide to expand with new products into new markets then you could end up with double the risk. Never underestimate the additional research and resource costs required to move into overseas markets. Also make sure you understand the country’s tax regime too, they may tax more heavily and more often so plan accordingly.
To increase your chances of success talk to an expert or your bank, they can help analyse the potential risks and highlight where the pitfalls are. Too many businesses don’t seek the proper advice and don’t realise the enormous implications of the risks they are running. A seemingly profitable venture can suddenly need a lot more cash if it’s to continue operating, but left too late the funding may simply not be available in time.
FD Recruit bring together the most prestigious Financial Directors from some of the UK’s most successful companies. The above comments are a summary of discussions from our latest conference. For more information about the FD Recruit events please email [email protected]
Date Posted: November 13th 2013
Posted By: Phil Scott