Growing a business may well involve consuming financial resources faster than profits can replenish them, and many otherwise healthy businesses fail because they run out of cash.

This guide will help you avoid cashflow crises and ensure your business is adequately and appropriately financed.

Why does growth bring increased financial concerns?

When the business you’ve built begins to really take off, it’s a time of immense pride and achievement. But as you pop open the champagne, bear in mind that growth is likely to bring with it some new financial concerns. As your business increases, so might your overheads. Operating costs will increase and your working capital requirement will grow. In other words, you’ll need more stock, more staff, more equipment and larger premises – and all these activities consume financial resources at an alarming rate.

Increased overheads

Overheads are the costs incurred by a business, and include rent, wages, utility bills and insurance. They are not attributable to any particular aspect of the business, but occur simply by virtue of the business existing. Rent has to be paid, whether the business is producing or not. With growth may come the need to get bigger premises and take on more members of staff. Insurance may also go up and, with more staff, utilities bills are likely to get bigger.

Increased operating costs

Operating costs are the expenses incurred by the business to buy stock, materials and services to allow a business to produce its core products and services. The greater the output of the business, the larger the operating costs will be. And so, if the business grows, output will grow and operating costs will grow too.

Increased working capital requirements

With growth, we have seen that overheads may rise and operating costs increase. The drain on working capital – the money that pays for the day-to-day running of the business – will thus increase. To make matters worse, as the business grows you probably need to hold more stock, and you have more customers to give credit to. All this ties up precious cash resources. So, for example, if a big bill comes in from a supplier, plus a VAT demand, and it’s pay day, all, or a combination of these could lead to a cashflow crisis for even the most profitable of companies.

Planning your cashflow

There are three ways to help ensure that your business has adequate cash to expand:

1. Make existing funds go further.
   
2. Access more funds.
   
3. Undertake regular cashflow forecasting.

One way to a healthier cashflow is to make sure your existing funds are actually in your hands as soon as possible by speeding up the collection of money owed to you.

Credit checking

You could start by ensuring that every customer you deal with is creditworthy and likely to pay. There are professional credit-checking agencies that can help you to identify high-risk customers, so you can put appropriate credit controls or conditions in place before doing business with them. You may decide to insist that any company that looks a risk pays in advance, or you could simply decide not to do business with them. You can also do this kind of credit-checking yourself. Ask your Business Manager for tools to help you do so.

Factoring and invoice discounting

These are two other ways of ensuring that you get paid on time, even if your customers choose not to do so. A factoring company will pay you about 90 per cent of the value of your invoices immediately, which will certainly help to improve your cashflow situation. The factors then usually take responsibility for the efficient collection of unpaid invoices, and the balance of each invoice is paid to you when it is collected. Effectively, this is a form of borrowing against the value of your debts and the cost is related to the interest rate charged on the 90 per cent advanced. In practice, you can expect factoring to cost you about three per cent of your invoice value.

Invoice discounting is similar to factoring except that you are responsible for your own debt collection activities. However, it’s perhaps more discreet because your customers need not know that you finance your business by borrowing against invoices.

Debt collection

As a last resort, you could call in a debt collection agency to chase your money for you. Most will offer two key services:

Collecting payments for overdue invoices – Most reputable debt collection agencies are highly effective at collecting. Company reminders are often ignored by late payers, but almost three-quarters of businesses and individuals pay up after a single letter from a debt collection agency. Reducing overdue invoices will improve your cashflow position and reduce your overall working capital requirements, and the improvement is likely to be made at moderate cost, as customers who are contacted by debt collectors are less likely to make late payments to you in the future.

Missing debtor and bad debt recovery – Most agencies can trace debtors who have ‘disappeared’ and collect payment for you. Some operate on a ‘no fee for no collection’ basis, so for debts you have already written off this is a risk-free proposition which can ease cashflow problems.

More ways to improve cashflow problems:

• Review your credit terms. Cashflow may be aided by offering early payment incentives, although these can sometimes backfire, leaving you with reduced income AND debts.
  
• Make sure someone is responsible for chasing late-paying customers in your business and put a strict process in place, ensuring payment is chased effectively and systematically.
  
• Employ strict credit management procedures to check existing and – especially important for growing businesses – new customers.
  
• To spot possible credit hazards, make sure you are aware of how successfully your key customers are trading, and the conditions of the industry in which they operate.
  
• Ask for payment up front for late-paying or potentially insolvent customers.
  
• Retail businesses may try running seasonal sales to generate some cash.
  
• For some businesses, it’s appropriate to stop the account of a bad debtor until they pay up – this is common in the publishing industry and very effective.

• Sale and leaseback of property or other capital equipment.
  
• Renting or leasing new equipment instead of purchasing it.

2. Accessing more funds

If watching your cashflow like a hawk isn’t enough, you may wish to consider additional funding. Bear in mind that any new finance will have to be paid for – either in interest payments or by giving up a share of your business. So it is obviously in your best interest to ensure you are making the best possible use of your existing finance before bringing in new capital.

However, if you have decided that your business needs additional financing to help fund its growth, then the two most likely options are:

High Street banks

The most common way for businesses to finance growth is through a loan or overdraft from their existing bank. As well as the possibility of a loan or overdraft, your Business Manager will be able to give you free advice. Of course, it is in their interest as well as your own that your business is successful, so take advantage of this.

Venture capital and business angels

For fast-growing and highly ambitious businesses it may be possible to get financing from a venture capital company, but the costs involved in checking out a company and its prospects are such that few are interested in lending less than six-figure sums. For expanding businesses looking for much smaller amounts of financing, a more likely solution is private equity, or business angel, capital.

The British Business Angels Association defines ‘business angel capital’ as ‘equity capital provided directly to new and growing unquoted businesses’. However, in addition to the actual financing, the business angel will offer their business skills and experience, and many will want to take an active role in guiding the business. This is often an attractive proposition for SMEs as it gives access to skills, experience and new ideas that they may not currently possess. Typically, a business angel is a successful business executive or ex-entrepreneur who invests between £50,000 and £750,000 either on their own or as a part of a syndicate. Business angels invest for a number of reasons ranging from the fact that they enjoy the buzz of working with a young company, to wishing to ‘give something back’.

However, all business angels are eventually anticipating making some money out of their investment. They will look to exit a business within three to five years, with a return of ten times their money. When seeking a business to invest in, angels will look at a company which has the potential for explosive growth. This is judged in equal parts on the strength of the management and the business itself.

Make your business attractive to potential lenders and investors

Although the fundamental soundness of your business is the most important thing a potential lender or investor will be interested in, bear in mind that 97 per cent of businesses are turned down by business angels in the early stages because they do not present themselves effectively. So begin by ensuring that your presentation is professional and thorough, and that there is a sound business plan in place – with real data to back it up.

In addition, there are a number of steps you can take to maximise the chances of getting successful funding:

• Reduce costs. Look at all areas of your business to identify and strip out unnecessary expenditure, or find cheaper alternatives. These may include subscriptions, travel, entertainment, telephone, logistics, insurance, premises and supplies.
  
• Stop production or provision of services that are not profitable.
  
• Reduce your own salary or benefits.
  
• Review staffing requirements. Can staff numbers be brought down by removing or consolidating some positions, without affecting the performance of the company?
  
• Review pricing. Can you justify an increase in prices charged to your customers?

As well as adequate financing, your business must be appropriately financed.

The advantage of a bank loan is that you retain ownership of your business. But a common mistake among businesses is to finance growth excessively through borrowing instead of profits. This can make interest payments an impossible burden if, for any reason, projected profits are not attained. This is why planning is critical and so is checking with the experts. Your Business Manager will be able to analyse your historical business performance and advise you on the most appropriate loan.

With equity finance you have to give up partial ownership of the business – and rights to a proportion of any future profits – in return for an injection of funds. Many entrepreneurs have difficulty parting with any proportion of ownership of their businesses, but management theorists suggest that they should be willing to use a proportion of the business as a way of financing its expansion. After all, owning 60 per cent of a large business is better than 100 per cent of a business that fails.

Useful contacts

The British Venture Capital Association

T: 020 7025 2950
W: www.bvca.co.uk

The British Business Angels Association

T: 0207 089 2305
W: www.bbaa.org.uk
email: info@bbaa.org.uk

Credit Services Association

The Credit Services Association (CSA) is the only national association for debt recovery agencies and allied professional credit services.

T: 0191 286 5656
W: www.csa-uk.com
email: info@csa-uk.com

Back