Growing a business will include significant challenges and exciting opportunities. As a company matures from a nascent startup to a growth state of business, the complexity of managing its finances often expands rapidly. A solid, dependable financial operation is important right from the beginning of a business’ startup phase. If key actions related to finance are ignored, then growth is inhibited and risk is taken unnecessarily. Throughout this conversation, practices within industries and real-life examples will be connected to the U.S. market, providing concise and actionable guidance to finance managers, small business owners, and entrepreneurial leaders.
Understanding Your Financial Baseline and Setting Clear Goals:
Before the organization embarks on any scaling journey, it’s important for it to have a good understanding of its current financial status.
To begin, look at your balance sheet, income statement, and cash flow statement from the last three years or from inception if you’re a newer business. Avoid the temptation only to look at the numbers and look a little deeper at critical measures:
1: Gross profit margin: Is this stable, improving, or declining from year to year? The average for retail businesses is about 40% and 60% to 70% for service businesses.
2: Operating cash flow ratio: This tells you if you are generating enough cash to meet your short-term liabilities from your operations, with the ideal being above 1.0.
3: Customer acquisition cost (CAC) vs Customer lifetime value (CLV): You will want your CLV to be at least three times your CAC for sustainable growth.
4: Accounts receivable turnover: That is how quickly you are collecting payments. Slow collections can make it difficult for profitable businesses to expand.
This analysis allows an organization to understand trends, like the fluctuations in cash flow during the off-season or the effect of rising fixed costs during heavy investment seasons. Comparing figures against industry benchmarks will be important after analyzing the financial statements. Organizations can use reputable data sources, such as the U.S. Small Business Administration and industry-related financial statements, to see how it compares with competitors. This benchmarking experience provides perspective and helps organizations set realistic financial goals in both the short and long term. The short-term financial goals might revolve around immediate cash management improvements or reducing costs, while long-term goals may be around expansion into new areas, profit margins, and growth in revenue. Many financial analysis tools and software like QuickBooks, Xero, and Magicbooks will help, in addition to the original analysis, with pulling necessary financial reports, tracking key performance indicators, and using historical data to project outcomes going forward.
Building a Robust Financial Infrastructure:
Once you have evaluated the baseline and have your financial goals in place, the next important area to focus on is creating a financial infrastructure. As a company grows, your financial processes also need to adapt to increasing complexity in the financial aspects of running operations. A robust financial infrastructure begins with developing a comprehensive budgeting and forecasting process. Well-designed budgets and revenue forecasts are not merely ex-post records, and properly designed budgets are critically important when making future investment decisions. Develop a habit of integrating your budgeting and forecasting as part of your daily financial planning to allow for better preparation for growth and to make allocation changes based on current circumstances. Investing in scalable accounting software or an all-in-one Enterprise Resource Planning (ERP) system such as NetSuite or SAP is an essential element of developing an efficient financial operation. These systems will not only streamline your day-to-day financial processes, such as invoicing and financial reporting, but also provide you with real-time data analytics that are crucial to timely decision making. Now that many businesses are in a digitally-first workplace environment, cloud-based platforms provide important remote access, security, and flexibility as companies expand to multiple geographical locations.
Assessing and Optimizing Cash Flow Management:
It is your cash flow – not profit – that will keep your doors open during rapid growth periods. Ironically, the very successes that cause your business to grow can also cause a cash crisis, and will spend more on capacity before seeing returns to start paying you back. You should begin by ensuring you have a rolling 13-week cash flow forecast that includes an estimated weekly cash-in and cash-out. The granularity of having cash flow projections for cash in and cash out weekly is vital to identify any potential cash flow limitations or obstacles before they become a crisis.
To optimize your cash position:
1: Speed up collections: marketing early payment discounts (for example, 2/10 net 30 is constructive), invoicing immediately versus batching, and follow-up reminders.
2: Negotiate better supplier terms: As your purchasing levels increase, use that purchasing leverage to negotiate better supplier payment terms. (for example, moving payments from net 30 to net 45 or net 60).
3: Think about inventory management: Just-In-Time inventory principles could help free up capital you’ve had tied up under inventory. Just remember that Just-In-Time is subject to supply chain reliability.
4. Put in cash conservation policies. Very few expenses are critical for growth: Determine which expenses are critical for growth versus not growing and have clear levels of approval.
Evaluating Financing Options:
As businesses evolve, it is a natural progression, in many cases, to find outside funding to help you scale. There is a range of funding options, each with unique benefits, caveats, and considerations.
When evaluating financing options for your business, consider the variety of debt financing available.
Debt Financing Options:
1. Conventional Bank Loans: These often require two years of profitability to qualify with market rates of approximately 5%-9% for established firms with good credit.
2. SBA Loans: Programs such as SBA 7(a) loans can provide up to $5 million dollars, with favorable loan repayment terms of 10-25 years; however, the application processing can often take 2-3 months.
3. Business Lines of Credit: Offer access to flexible funding amounts (usually $10,000 to $500,000) and only requires payment on amounts utilized, often useful for managing seasonal variability or accounts receivable gaps.
4. Equipment Financing: Lets you maintain cash flow and often finance between 80%-100% of equipment costs, utilizing the equipment will serve as collateral in the loan transaction.
5. Revenue-Based Financing: A newer funding option that allows you to pay back based on monthly fluctuating revenues (typically between 3% – 8% of monthly revenues) until reaching a predetermined cap of 1.3x to 2.5x the initial borrowed funds.
Shareholder Investment Routes:
1. Angel investors: They will generally invest $25,000-$500,000 for equity of 10-30% and can add value with experience and connections.
2. Venture capital: Interested in companies that are fast growing and disruptive, or about to be, they will invest at least $1 million for a meaningful equity stake and board representation.
3. Private equity: For an established company, PE firms will invest approximately $5 million for a controlling interest with a typical exit in 5-7 years.
4. Strategic partnerships: Industry-related organizations will occasionally be willing to invest capital in your company in return for distribution rights or access to technology, or entry into the market.
Your ideal funding mix must account for your timeline to growth, risk tolerance, and desire for operational control. Many businesses that are successful use a layered structure: some debt for predictable expenses—such as equipment and facilities—and being hefty on equity to spur fast market growth or attract funds for other R&D efforts with uncertain returns.
Financial Forecasting and Data-Driven Decision-Making:
Strong financial forecasting is a crucial component of an effective business strategy. Financial projections enable companies to anticipate changes in revenue, expenses, and profit margins and provide a window through time that helps inform strategic planning. There is quite a range of forecasting techniques, from simple trend analysis to complicated regression models and scenario planning, each method building on the sophistication of the traditional financial models. The use of business intelligence tools such as Power BI, Tableau, and Looker has become the norm by many companies in the United States, as these systems help existing companies translate raw data into insight that improves financial decision-making. Scenario planning modifies the value of forecasting by giving businesses a leg up to deal with unexpected changes in the market.
By building out alternative projections for various market conditions, businesses can see prospective opportunities and risks develop in advance. For example, a small regional retail chain recently struggled to understand the underperformance of a segment in its product portfolio. The retail chain now uses dynamic forecasting and identifies which segments of the portfolio are causing drag on the overall revenue growth. Their findings allowed them to reallocate resources and waste to hear from, and then capture, the market share during a down economy. Combined with the use of real-time (big) data analytics, financial forecasting is not simply a one-off process but an ongoing dynamic that continually refines strategic decision-making as new information comes into the market. Financial projections keep every financial decision minimized to as least dated market event possible.
Implementing Risk Management and Building a Financial Safety Net:
Scaling your business may bring in fresh vulnerabilities. The financial cushions that were suitable for a $2 million business just may not be the same for a $10 million business as there is a reliance on some of the same customers, suppliers, or employees.
With a scaling business, you need to have a full-blown risk management strategy that includes:
1: Liquidity reserves: You should have cash reserves of at least 3-6 months of operating costs — more if you or your industry is impacted by volatility or seasonality.
2: Make sure that you review your insurance coverage semi-annually for your property, liability, business interruption, cyber risk, and key person insurance when you are scaling. Insurance that may have seemed excessive last quarter may be totally inadequate moving forward.
3: No one customer should make up more than 15-20% of your revenue. If one customer does make up more than 15-20%, you will want to have risk mitigation strategies.
4: Supply chain redundancy: Qualify backup suppliers for key components and test them regularly for the capability to deliver.
5: Stress testing: You will want to model how your business would react to a significant disruption such as a loss of a top customer, supply chain breakdown, sudden legislation change, or key employee leaving.
Navigating Taxation and Regulatory Compliance:
Tax responsibilities get more complicated as you move into new thresholds with your business – whether the threshold is with respect to revenue, employee numbers, or geographical reach. What worked for a smaller business could put you at legal risk because of compliance needs when you increase your scale. Your original business structure as you scale (LLC, S-Corp, C-Corp) might not make sense anymore. An example of this is the fact that all companies who will raise a lot of venture capital money down the road will probably need to be in a C-Corporation structure.
Every state has different nexus standards on when you actually have to start collecting and remitting sales tax or paying income tax in that state. The straddle and the outcome of Wayfair in 2018 expanded the obligation to many growing businesses. You might also be entitled to larger targeted programs from states, such as R&D credits, work opportunity tax credits, or location-based incentives that smaller businesses would not be eligible for. If your business expands internationally or across multiple entities, you may have to implement transfer pricing policies formally as well.
Conclusion:
Expanding your business entails great potential as well as financial risk. The process of addressing these crucial financial areas lays the groundwork for scalable growth. Consider that financial excellence is not a hindrance to entrepreneurial innovation, but it permits a business to explore that innovation in an informed manner with adequate resources and guardrails. The best scalable organizations combine bold vision with diligent financial management. As you go about executing these steps, keep in mind that you don’t need to be perfect. Focus on the areas most important to your specific business model, build momentum through your early wins, and improve your process as you scale. Growing from a small business to an industry-leading organization will undoubtedly come with financial challenges. By preparing for those challenges and intentionally building robust systems to handle those challenges, you build potential challenges into competitive advantages. Your investment in financial excellence now creates the basis for your business excellence tomorrow.
What first financial item will you address in your scaling process?
