Your business may have been around for some time. Revenues are growing, margins are expanding, and cash inflows are stable. Sure, you have already thought about expanding to maximize your capacity. But you still hesitate to make the first move as market volatility remains visible.
Inflation is cooling down, but interest rates are yet to reach their maximum. With the looming recession, getting stuck in debt may deplete your finances. Fortunately, you can execute your plans with careful financial preparation. This article will provide some pointers to avoid overleveraging in a high-inflation environment.
Tip 1: Create a Concrete Budget Plan
Do you want to expand your business to other areas? You may have to increase your capital expenditures (CapEx) and production inputs. Do you wish to increase your production level? Who knows, you will only have to increase your inventory level. But either way, there will be higher fixed costs, such as utilities, rent, and salaries.
There may also be legal costs if you plan to expand to other states. Aside from increased expenditures, you must understand the state laws and tax systems. It’s a good thing business expert providers like doola can help you accomplish your goals. They will explain all the business and legal details and tips you need.
Given this, you must create a concrete and realistic budget plan. Estimate revenues, costs, and expenses. Will margins increase, decrease, or stay the same? The first year of expansion is often less viable due to many adjustments. So, you must prepare a financial projection for at least three years to know if it’s worth the try.
Tip 2: Reassess Your Financials
Your business sustainability relies on more than revenues alone. You must check all financial statements to reassess them. Depending on the industry, some accounts can give you a quick snapshot of your business’s fundamental health.
The easiest method to use is the Quick Ratio, which tells about the liquidity of your business. Can your current assets—excluding inventories—cover current liabilities? To be more specific, determine how high your cash is relative to the total assets. Remember, cash is king, whether in times of expansion or contraction.
Also, check your inventories. How long can you store your materials? How much time do your products take to get sold? From there, check your revenues relative to assets using the Asset Turnover Ratio. It will help you determine which of your assets are performing or not. You may sell non-performing assets to generate proceeds and improve efficiency. Doing so enables you to avoid overproduction and unnecessary borrowing.
Tip 3: Check Your Capacity to Repay Extra Borrowings
After assessing your overall financial health, check if you can increase your financial leverage. Compare your cash to the outstanding borrowings. If you have more than enough, you can expand without borrowing.
Another way is by checking your operating cash flow and CapEx. Their difference is your Free Cash Flow (FCF). You have enough cash inflows to cover borrowings and dividends if FCF is a positive value. Also, compare it to revenues using the FCF/Sales Ratio. The higher the ratio, the higher the capacity of your business to turn your revenues into cash.
Lastly, check the Net Debt/EBITDA Ratio to know if your earnings can cover borrowings. Typically, the ideal ratio is below 4x. If your business is capital-intensive, a ratio of 4.5x is still acceptable.
Tip 4: Restructure Borrowings
If you still don’t fully grasp the dos and don’ts of expansion, chances are you may not get loans with the most optimal interest rates. As you build and diversify your business portfolio, ensure a steady income flow. Doing so will help you restructure or refinance your existing borrowings. It is vital today as interest rate hikes persist.
Time to Expand and Sustain a Larger Capacity
Once you meet the standards, time to execute your expansion plan. Be more patient and cautious since it may take a year to adjust. Watch your business performance and cash flows closely. Check the financial ratios and compare them to your previous financials. In time, you will know if your business is better off with a larger operating capacity and do something to improve processes.
Expansion is an exciting yet risky move for your business. Your business may thrive further if done with proper planning. Otherwise, all your effort and money will go down the drain. You must have the right timing and determination to succeed even in the face of market disruptions.