As a business owner, the day you land your first big league client is always exciting. It feels like you’ve finally made it. The new contract might double or triple your revenues, and forces you to finally take the leap and scale up your business. Unfortunately, for many less experienced business owners, it’s only then that it finally becomes apparent that the real challenge is only beginning. Rapid growth is expensive and can make cash flow management much trickier than you’re used to.
The costs of growth
You’ll need to acquire new equipment, hire and train new employees, get access to the real estate you need to service your new clients, and purchase the inputs you need to fill your orders, all practically overnight. This new infrastructure as well as increased marginal costs like labour and materials need to be funded by your business up front, which will inevitably put prohibitive stress on your budget.
Simply paying up and waiting to get reimbursed is almost never a viable option. Big business clients can take months to process and issue payments, and that’s after the product has been delivered and the client has been billed. The gap between investment and corresponding returns gets even wider during a growth phase like this, because it also means paying and waiting for infrastructure growth before you can begin production. During this time, your business needs to find a way to stay solvent or it risks failing before it can ever really take off.
Reducing the cash conversion cycle
A simple, brute force method for dealing with this kind of cash flow situation might be to try to take out a loan that can cover your operating expenses for this entire period, but that’s unlikely to be an option for most small businesses. Even if your business has the assets to secure such a loan, those funds could be better spent in other ways. Instead, you can reduce the burden by using financing tools that can shorten your cash conversion cycle, minimising the waiting period between making your investment and receiving your returns.
Supply chain finance
Fifo Capital’s supply chain finance allows businesses to pay suppliers out of a credit fund that’s furnished by its investors. The business can then opt to delay paying off the balance on that fund by a set period, perhaps 60 days. This gives the business an additional two months during which they don’t need to find other sources of capital to stay solvent.
Even the substantial reduction in your cash conversion cycle that supply chain finance offers is unlikely to cover the period between invoicing and the actual arrival of your long-awaited revenue. To address that, businesses can use invoice financing to receive most of their payment at the time that the invoice is issued. By giving you access to your revenues sooner, this also reduces the total amount of financing you’ll need to cover increased marginal costs that resulted from growth.
Depending on your initial payment terms and the length of your production cycle, using both of these tools together could be enough to result in a negative cash conversion cycle. This is a best case scenario, where you would receive payment for your goods and services before you’re forced to pay for the investment that produced them. It’s more likely, though, that you’ll instead just shorten the cycle while still leaving some amount of time during which you’ll need to finance the investment on your own.
Managing the remaining costs
A shortened cash conversion cycle is less expensive to deal with than a longer one, but you’ll likely still need outside financial support to manage the costs. There are a number of good ways to deal with this…
Growth oriented loans
An obvious and popular choice is to simply take out a business loan. This is a simple way to get a set amount of funding to cover general costs. Unfortunately, you might not have the assets you need to secure such a loan, or to get one as large as you need.
A good way to access additional capital when needed is to take out a stock loan. As the name implies, stock loans can only be used to purchase stock, so they’re not as versatile as a regular business loan. What makes them great is that they are secured against the stock purchased with them. That means you can get one even if you don’t have any assets available to secure against a loan.
Investors are another excellent source of liquid capital for growth. Unfortunately, businesses usually won’t have time to reactively attract new investors to cover the costs of this type of rapid growth. For businesses that already have ongoing and robust investor relationships, however, these are an excellent way to come up with additional capital.
By understanding the cost of growth, and planning for the challenge in advance, you can ensure that your business will survive its sudden growth spurt, and come out on the other side stronger than ever.