If you have decided to grow your business, it's essential that you detail all the costs incurred in getting your growth option underway and compare them against the anticipated profits.
You must be realistic and practical when setting growth objectives. Will you have enough money to finance the development without impacting on the funding for your core activities?
Sound financial planning is the foundation of any growth strategy. You will need to establish:
- how much investment is required to fund the venture
- when it will be needed
- when it will be available
- how soon you will be in a position to repay the capital
A detailed cashflow forecast is essential, not least because outgoings are almost certainly going to rise sooner and faster than revenues. Enough money must be in the pot to keep the core business running. It's a good idea to build in some surplus too, as most projects always take longer to bear fruit than originally predicted. Detailed forecasts regarding sales, working capital and sources of seed funding, and even second round funding will need to be drawn up.
See the Raising Finance| pages for information about how to fund growth plans.
One of the most popular ways of calculating if your growth plans will provide the expected benefits is to test them using the Return on Investment (ROI) formula. This will tell you what percentage of return you will get over a specified time. Three years is a good rule of thumb used by many expanding businesses.
ROI is determined by taking the total invested, working out the increased sales it will generate each year and the resulting net profit, then calculating that as a percentage of the investment.
For example, suppose a business wants to add a new product line that it predicts will cost an investment totalling £200,000 in development costs, plant, marketing and promotion. It estimates the new line will generate £400,000 in sales and £40,000 in net profit each year.
|Timescale||Additional net profit in period||ROI calculation (net profit / investment x 100)||ROI (%)|
|One year||£40k||40k/200k x 100||20|
|Three years||£120k||120k/200k x 100||60|
|Five years||£200k||200k/200k x 100||100|
It's a good idea to test the ROI with a number of different sales figures. While you may think additional sales could reach £400,000 a year, a number of factors - such as development problems, delays or sales and marketing issues - may result in lower sales in the early stages. You may also wish to adjust your calculation to allow for annual inflation.
Please see our Financial Planning| page for further details.