One of the reasons companies that were once profitable start failing is overexpansion. If you don’t carefully plan for your business expansion, there is a high likelihood that the new venture will drain your cash flow and reduce the parent company’s profits.
On the other hand, if business expansion is carried out properly, you’ll have higher profit, more income stream diversification, and an expanded client base. Notably, you should always weigh the rewards and risks to determine if your expansion plan should be a business acquisition, increased production, a new business location, or introducing a new product into the market. This article will explore the financial considerations you should consider when planning a business expansion.
1. Finances
Finances are the central pillar of business expansion. You should evaluate the best means to fund your growth. Your options could range from cash reserves, surplus from expected revenue, loans from lending institutions, or increasing prices on your existing products. If you rely on increased revenue, your expansion plans can only be complete if your sales reach the expected projections.
Taking a loan to expand means you will have to factor in the loan’s interest as you set the pricing for your products. Take into account the financing options, credit lines available, and cash flows from the previous year, then come up with a post-expansion cash flow projection. This will give you a clearer perspective if you need a loan for the expansion. While at it, consider the pros and cons of business loans.
Find out how much your profits will be after all the costs, including interest paid on loans, and the duration it will take you to break even, then decide whether an expansion is the best option. You can consider a working capital loan if the three factors below are part of your business expansion plan and the funds are inadequate.
Marketing:
Any new business venture or expansion requires extensive marketing and building brand recognition. Your clients need to know what differentiates your products from what is already in the market. If you are introducing a new product, they must also be aware of it and what it entails.
Digital Transformation Campaigns:
The evolution of online shopping platforms and digital marketing has necessitated regular online campaigns. You should have a budget for online marketing campaigns.
Seasonal Inventory:
One of the business expansion strategies is increasing production. That means that you should have enough inventory as you start expansion. You’ll need a lot of working capital to stock the inventory while keeping in mind that consumer spending habits keep changing.
Having enough working capital will allow you to outsource some of these functions so that you can focus on other areas of your growth expansion.
2. Manufacturing And Overhead Costs
Your profit margins will be affected differently depending on your chosen expansion method and the overhead costs involved for each business expansion type. If you’re expanding by introducing a new product in the market or setting up a new location, your economies of scale will differ. For example, if you’re establishing a new site, you can always split costs, like marketing costs, between the two companies.
However, if you’re introducing a new product, you’ll incur double the marketing charges. Still, expansion by increasing sales is much more cost-effective than expanding by selling a new product. You will incur a higher production cost for a new product, and sometimes it may even require you to set up a new production facility.
3. Pricing
The primary determinant of your profitability is the price of your service or product. Have the right pricing strategy and stick to the below basic pricing rules.
- If you intend to lower prices, reduce the cost of production as well.
- The prices should cover expenses and profit.
- The price you set should guarantee you sales.
- Periodically review your prices concerning the cost dynamics, market demand, and competition.
Your price should cover you in all aspects and include the cost of loan repayment, inventory, markdowns, damaged goods, wages, commissions, cost of property or equipment leases, and all other operating expenses. The price should help you break even and give you sustainable profits. Therefore, before you set the price, you must conduct market research.
Sometimes, lowering your prices can be a market entry and penetration strategy. However, if you expand through a business acquisition, you may be forced to hike the prices to cover the business expansion cost temporarily. Note that increasing prices will have a ripple effect on your sales volume, demand, and profit margins.
Conclusion
For any business, the business expansion phase comes with its challenges and risks. So, take your time to come up with a viable expansion plan. You can consider other options like partnerships if you’re ready for an expansion but need more resources. Ensure you have enough financial resources before you begin, and remember that perfect timing is critical.
