Managing financial growth requires you to understand the fundamentals of persistence and balance
By: Phoenix Lee/
Managing the finances of a growing business requires persistence and balance. To obtain the funding needed to finance growth, you must understand the roles of these concepts and how to apply them in managing a growing business. A brief discussion of these concepts follows.
Managing financial growth by understanding persistence
In a growing business, financial resources are often viewed as the major factor limiting growth potential. There are two methods of improving your financial base:
- grow gradually and allow profits to fund additional growth and
- seek outside funds (i.e., debt or equity funding).
Either approach will consume time and energy, and you will experience some rejections. This is where persistence is important. Your determination, combined with a willingness to adjust your plans, will carry you through this process.
Sustained growth puts stress on you and the financial resources of your business. Achieving growth goals often takes longer than you initially planned. However, you are not alone in the quest for growth and expansion. Many successful business owners have experienced the same problems and frustrations. To understand the challenge ahead, visit successful local business owners and read articles or books about their experiences. Many well renowned publications and online articles contain stories about successfully your growing businesses and managing financial growth.
Sometimes, the business section in the mainstream newspaper features local success stories. Also, chambers of commerce are excellent sources of information on local businesses. Don’t hesitate to take advantage of these resources. You can learn valuable techniques and concepts that will enable you to avoid many of the problems other business owners have encountered.
Managing financial growth by understanding the art of balance
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. To avoid this dilemma, devise policies to balance the operational functions of the business with the financial aspects of growth.
Here are several guidelines to help you in managing financial growth:
- Growth should be attempted only in businesses already profitable. To attain profit potential, a balance must be maintained between asset and liability items that are on the balance sheet and operating items that are on the expense and income reports. For example, if accounts receivable on a balance sheet average $50,000 and sales average $500,000 per year, a balance of 10 percent exists between these items. If growth is obtained in part by offering easier credit terms, the balance could be altered if the accounts receivable average $150,000 and are used to support sales of $1,000,000. Thus, the balance needed to maintain a profit has been altered. When growth is undertaken, profit will be negatively affected, at least initially.
- The existing debt position of the business must be balanced with equity, or additional equity must be obtained to balance future debt. The rule of thumb is for the equity position on a balance sheet, expressed as equity divided by assets, to range from 30 to 50 percent. If your business has an equity position of less than 30 percent and you wish to obtain financing for growth, a certain amount of money will have to be injected as equity to finance additional debt.
- Management skills and abilities must be balanced with the increasing demands on management in a growing business.
There are several simple examples of balancing opposing forces that can be applied to business. One example is the financial management concept. Financial management compares your company’s growth potential when financing the entire growth phase by reinvesting profits to financing through an infusion of cash from outside sources. The latter option accelerates growth; it follows the concept of leverage and allows you to use equity to obtain additional money so the business can grow faster.
For example, if you can use a 33-percent equity position and invest $100,000 in a business, you can borrow $200,000 for a total investment of $300,000. This allows the business to grow faster than using only the $100,000.
When accelerating growth, the financial leverage concept works only as long as the business is profitable or the return on investment exceeds the debt expense. When this happens, the rate of return received on the equity investment is greater. For example, if you invested only the $100,000 and did not borrow any additional money, the rate of return might be 10 percent.
However, if you used the $100,000 to obtain $200,000, and if the debt is 12 percent and you make a return of 15 percent on the entire project, the resulting rate of return on the $100,000 is higher. The 3 percent made on the debt results in a total dollar value of $6,000. The 15 percent made on the existing equity (which would be $15,000), combined with the $6,000 made on the debt would result in a final return rate of 21 percent on the equity portion.
Profitability is important to business growth because it makes it easier to obtain the financing needed to expand. This is the opposite of how accounting systems are normally operated for tax purposes. To reduce taxes, accountants and business owners often try to show a loss or as little profit as possible, which allows the business to retain more cash. From this standpoint, perhaps your business should be profitable for several years before initiating a growth phase.
In many cases, however, you will not or cannot take the time to accomplish consistent profitability. If you are planning to expand your business, discuss this process with the accountant who prepares your income statements or taxes in order to legitimately transfer forward some of your current operating expenses, thus increasing your current profits.
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