Growth is good, right? Not always. Unplanned or too-rapid growth can lead to cash flow problems and, in the worst case, to outright business failure.
You can avoid a bad outcome by knowing what to steer clear of, understanding your alternatives, and choosing carefully.
What to Watch Out For
Planned growth is what you want, and planning ahead requires a financial forecast. Here are the items you’ll need to create one:
- A sales forecast that projects sales three to five years out.
- A balance sheet that shows your assets, liabilities and equity at the end of your most recent fiscal period.
With these in hand, your accountant (or a software program) can apply the sales forecast to the balance sheet to project it forward in time. Once this is done, you can use key ratios to gauge how fast you can grow and stay safe.
A fundamental measure of your firm’s safety is the debt-to-equity ratio, which compares total liabilities to your equity or investment. The higher your debt is in relation to equity, the higher your risk of liquidity or solvency problems.
If a growing debt-to-equity ratio is what you see in your financial forecast, consider it a warning light – one that signals the need to think hard and make careful choices.
Understanding Your Alternatives
If accelerating growth remains your objective, there are three basic ways to fund it:
- Boost equity by increasing your investment of personal resources in the company. This can come from either retained earnings or other personal resources, if available.
- Bring new equity in from the outside by selling an ownership interest to a partner or a group of investors. One potential drawback here is that the long-term value handed to new partners may substantially exceed the cost of a loan.
- Fund growth with additional debt. This will require approval from a lender and may mean added risk, but it will allow you to retain full ownership of your business.
There is, of course, a fourth alternative, and that is to minimize risk by limiting growth – i.e., adjusting growth targets to levels that won’t cause debt to increase relative to equity.
Choosing between these options isn’t easy. You will have to ask yourself some hard questions, including:
- How important is it to accelerate growth?
- How much risk should I tolerate?
- Which is more important to me – growth or retaining ownership and control?
- How much debt can I safely take on given the dynamics of my business and the market?
If you opt for debt financing, you will want to increase your chances of qualifying by presenting as much documentation as possible. Here’s a partial checklist:
- A current balance sheet
- Up to three years of financial statements
- A sales forecast
- A financial forecast
Finding the Funding That’s Right for You
Keep in mind that bank lenders will pay close attention to matching sources and uses of funds, particularly with respect to time. Matching typically involves either term loans or lines of credit.
With a term loan, you borrow a specific amount of money from the bank at a set interest rate that must be repaid within a certain period of time. These loans are generally used to support long-term purposes and are typically repaid from retained earnings.
With a line of credit, you are approved to borrow up to a certain amount of money whenever you need it, with repayment made from cash flow. Lines of credit should be used to fund capital needs that can be repaid within one year.
Expect the loan underwriters to focus very closely on how much debt your cash flow and earnings will cover, and how well sources and uses match.
To speak with a Business Banker about your funding needs, call (800) 773-7100.