Business growth is exciting! More customers, bigger orders and more employees.
So why does your overdraft keep getting bigger? And how can you fund business growth without an overdraft?
It is one of the most frustrating situations a successful business owner can face. It’s something we’ve explored in our article on the cash-flow trap.
You aren’t borrowing money because the business is failing. You’re borrowing because the business is growing.
But if every new contract requires you to put more money into the business before you get paid, growth can start to feel like a financial burden rather than an achievement.
The answer isn’t necessarily to stop growing. It’s to understand how to fund business growth without running out of cash that leads to shrinkage – or worse!
Why does growth need so much cash?
To the public who only read the headlines, a growing business that is selling more must also have a lot more money to spend. But that’s not always the case!
Imagine you win a new contract worth £250,000. That’s fantastic news.
But before that £250,000 reaches your bank account, you might need to:
- Employ additional staff
- Buy materials or stock
- Pay suppliers
- Invest in equipment
- Increase production
- Cover additional premises or transport costs
You could therefore be making a healthy profit on the contract. But before you get paid you must find tens of thousands of pounds to fund it.
This is the working capital gap.
The ICAEW explains that growth itself can create cash-flow problems. That’s because every additional sale needs to be funded. At the same time, stock and customer credit can tie up cash before the money reaches your bank account.
That’s why a profitable business can still find itself regularly relying on its overdraft.
Is your overdraft funding growth – or covering a problem?
An overdraft isn’t necessarily a bad thing. It can be a useful financial tool.
The problem comes when it becomes a permanent part of your business model.
If you’re constantly close to your limit, it is worth asking why.
Perhaps your customers are taking too long to pay. Or you may be holding too much stock.
Perhaps your margins aren’t as strong as you thought. There’s also a chance you might be withdrawing too much money from the business.
Or perhaps you’re genuinely growing faster than your existing cash resources can support.
Those are very different problems – and they require very different solutions. Regular management accounts can help you see exactly what is happening before a cash-flow problem becomes a crisis.
Start with the cash you already have
Before looking for external finance, look at whether you are making the best possible use of the cash already flowing through the business.
Get paid faster
A sale isn’t really helping your cash flow until you’ve been paid. So, review your payment terms, invoice promptly and make it easy for customers to pay.
And don’t allow overdue invoices to become somebody else’s interest-free finance.
Late payment remains a significant problem for UK businesses. The Government’s latest work on the issue states that late payments cost the UK economy almost £11 billion a year and affect more than 1.5 million businesses.
For a growing business, tightening credit control can therefore release cash without borrowing a single pound.
Look at your working capital
How much money is tied up in:
- Outstanding customer invoices?
- Stock?
- Work in progress?
- Deposits and prepayments?
The British Business Bank explains that effective working-capital management can reduce the need for growth finance. It recommends understanding your current working capital requirements, projecting future needs and considering how you can ensure you have sufficient cash available.
This is often where an accountant can add real value.
It’s not just about how much profit you are making, it’s about how much cash the business needs to generate that profit.
Could you fund business growth from retained profit?
If your business is profitable, one of the simplest ways to fund future growth can be to retain some of that profit within the company.
That might mean taking a little less out of the business today so that you have more resources available for tomorrow’s opportunities.
Of course, the right balance will depend on your personal circumstances, tax position and business plans.
But it is worth asking: Do we need to take all of the available profit out of the business?
Or could retaining some of it create a stronger financial foundation for the next stage of growth?
This is one of the conversations that becomes increasingly important as a business moves beyond the £1 million turnover mark.
Don’t wait until you need finance
One of the biggest mistakes businesses make is waiting until the cash is tight before thinking about funding.
By then, the conversation with a lender can feel very different. Instead, think ahead.
If you know that a new contract will require £100,000 of working capital over the next six months, you have time to consider your options.
You might decide to:
- Build up cash reserves
- Negotiate better customer payment terms
- Agree extended terms with suppliers
- Arrange an overdraft facility
- Consider invoice finance
- Take a business loan
- Use asset finance for equipment
- Combine several approaches
The British Business Bank’s guide to working-capital finance outlines a range of finance options available to businesses, with the appropriate choice depending on factors such as the business model, stage of development and the reason finance is required.
The important point is that finance should be part of your growth planning, rather than an emergency response.
What will your next £500,000 of turnover cost you?
This is a question worth asking before you chase the next big contract.
If you increase turnover by £500,000, what happens to:
- Payroll?
- Stock?
- Suppliers?
- Premises?
- Vehicles?
- VAT?
- Debtors?
- Working capital?
The answer might be that the additional sales will generate substantial profit.
But if you need £150,000 of additional cash before that profit arrives, you need to know where the £150,000 is coming from.
This is why a cash-flow forecast is so valuable.
It allows you to model the impact of growth before committing to it.
Growth should make your business stronger
The goal shouldn’t be to avoid using finance. Good businesses use finance all the time. It is to make sure that the finance you’re using is helping the business move forward rather than simply plugging a hole.
There is a big difference between purposely using your overdraft to grow than forecasting cash requirements for growth and arranging the right funding to support it.
The latter is a business that is in control.
Are you funding growth efficiently?
If your turnover is increasing but your overdraft seems to be increasing at the same time, don’t simply accept it as the price of growth.
Look at the numbers. How quickly are customers paying? How much cash is tied up in stock? What are your margins?
And how much profit are you retaining? Before deciding how much profit to retain in the business, it’s worth understanding where your profit is being made – and where it may be leaking away.
You also need to ask what your cash position look like in three, six and twelve months.
And what will happen if your next major customer pays 30 days later than expected?
Those are the questions that turn cash-flow management from a reactive exercise into part of your growth strategy.
Want to avoid using your overdraft?
At Concept Accountancy, we believe your accountant should help you understand not only how profitable your business is, but what your growth is going to require financially.
It’s not just about avoiding using an overdraft – where the interest is usually high – but how to fund business growth to make your business stronger.
If that’s you, then get in touch. We’d be delighted to chat about how we can help you.
