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U.S. Small Business AdministrationEB-7FINANCIAL MANAGEMENTFOR THE GROWING BUSINESSBryan ZieglerDirectorIndian Hills Community CollegeSmall Business Development CenterOttumwa, IowaEmerging Business SeriesCopyright 1990, Bryan Ziegler. All rights reserved. "How to Write a Business Plan." Copyright1990 Linda Pinson and Jerry Jinnet. No part may be reproduced, transmitted or transcribed withoutthe permission of the author. SBA retains an irrevocable, worldwide, nonexclusive, royalty-free,unlimited license to use this copyrighted material.While we consider the contents of this publication to be of general merit, its sponsorship by the U.S.Small Business Administration does not necessarily constitute an endorsement of the views andopinions of the authors or the products and services of the companies with which they are affiliated.All of SBA's programs and services are extended to the public on a nondiscriminatory basis.TABLE OF CONTENTSINTRODUCTIONManaging Financial GrowthThere Is No One Right WaySECTION 1: OBTAINING CAPITAL FOR GROWTHDeciding to Actively Pursue GrowthEstimating Expansion CostsObtaining FinancingSECTION 2: MANAGING CAPITAL

Effective Cash Flow ManagementTechniques for Reducing CostsSECTION 3: DOCUMENTING RESULTSYour Accounting SystemTax Consequences of GrowthSUMMARYAPPENDIXESA. Sample Balance Sheet and Income StatementB. Sample Pro Forma StatementsC. Blank FormsD. Self-Assessment QuestionnaireE. How to Write a Business PlanF. Information ResourcesINTRODUCTIONAn expanding business offers the potential for numerous growth opportunities. Employees benefitfrom business growth through increased earnings and promotions. Customers benefit from expandedproducts and services. Owners benefit through increased profit potential. Society benefits throughthe new jobs created. Managing this growth, although rewarding, can challenge your skills andfinancial resources.Financial management involves all the activities that enable a company to obtain capital for growth,allocate resources efficiently, maximize the income potential of the business activity and monitorresults through accounting documents. Such management requires a well-written, comprehensivefinancial management plan clearly outlining the assets, debts and the current and future profitpotential of your business.This publication discusses the how to approach to financial management (i.e., a method that makesthe growth process easier to understand and implement), in addition to providing generalinformation on the challenge of managing financial growth. It is divided into three sections, witheach focusing on important aspects of financial management: Section 1: Obtaining Capital forGrowth; Section 2: Managing Capital and Section 3: Documenting Results.Successfully managing financial resources is important in new and expanding businesses, so taketime to develop and implement a financial plan that will ensure the success of your business.Managing Financial GrowthManaging the finances of a growing business requires persistence and balance. To obtain thefunding needed to finance growth, you must understand the roles of these concepts and how to applythem in managing a growing business. A brief discussion of these concepts follows.

PersistenceIn a growing business, financial resources are often viewed as the major factor limiting growthpotential. There are two methods of improving your financial base: (1) grow gradually and allowprofits to fund additional growth and (2) seek outside funds (i.e., debt or equity funding). Eitherapproach will consume time and energy, and you will experience some rejections. This is wherepersistence is important. Your determination, combined with a willingness to adjust your plans, willcarry you through this process.Sustained growth puts stress on you and the financial resources of your business. Achieving growthgoals often takes longer than you initially planned. However, you are not alone in the quest forgrowth and expansion. Many successful business owners have experienced the same problems andfrustrations. To understand the challenge ahead, visit successful local business owners and readarticles or books about their experiences. Inc., the Wall Street Journal and some of the generalbusiness publications, such as Business Week, Forbes and Fortune, all contain stories aboutsuccessful growing businesses. The business section in your local newspaper features local successstories. Also, area development corporations and chambers of commerce are excellent sources ofinformation on local businesses. Don't hesitate to take advantage of these resources. You can learnvaluable techniques and concepts that will enable you to avoid many of the problems other businessowners have encountered.BalanceThe financial and operational aspects of growth must be balanced when you expand your business.During a growth phase, for example, the marketing function of the business may extend beyond thebusiness's financial capacity to sustain growth. To avoid this dilemma, devise policies to balance theoperational functions of the business with the financial aspects of growth.Here are several guidelines to help you balance the finances of a growing business.!Growth should be attempted only in businesses already profitable. To attain profitpotential, a balance must be maintained between asset and liability items that are onthe balance sheet and operating items that are on the expense and income reports. Forexample, if accounts receivable on a balance sheet average 50,000 and salesaverage 500,000 per year, a balance of 10 percent exists between these items. Ifgrowth is obtained in part by offering easier credit terms, the balance could be alteredif the accounts receivable average 150,000 and are used to support sales of 1,000,000. Thus, the balance needed to maintain a profit has been altered. Whengrowth is undertaken, profit will be negatively affected, at least initially.!The existing debt position of the business must be balanced with equity, or additionalequity must be obtained to balance future debt. The rule of thumb is for the equityposition on a balance sheet, expressed as equity divided by assets, to range from 30to 50 percent. If your business has an equity position of less than 30 percent and youwish to obtain financing for growth, a certain amount of money will have to be

injected as equity to finance additional debt.!Management skills and abilities must be balanced with the increasing demands onmanagement in a growing business.There are several simple examples of balancing opposing forces that can be applied to business. Oneexample is the financial management concept. Financial management compares your company'sgrowth potential when financing the entire growth phase by reinvesting profits to financing throughan infusion of cash from outside sources. The latter option accelerates growth; it follows the conceptof leverage and allows you to use equity to obtain additional money so the business can grow faster.For example, if you can use a 33-percent equity position and invest 100,000 in a business, you canborrow 200,000 for a total investment of 300,000. This allows the business to grow faster thanusing only the 100,000.When accelerating growth, the financial leverage concept works only as long as the business isprofitable or the return on investment exceeds the debt expense. When this happens, the rate ofreturn received on the equity investment is greater. For example, if you invested only the 100,000and did not borrow any additional money, the rate of return might be 10 percent. However, if youused the 100,000 to obtain 200,000, and if the debt is 12 percent and you make a return of 15percent on the entire project, the resulting rate of return on the 100,000 is higher. The 3 percentmade on the debt results in a total dollar value of 6,000. The 15 percent made on the existing equity(which would be 15,000), combined with the 6,000 made on the debt would result in a final returnrate of 21 percent on the equity portion.Profitability is important to business growth because it makes it easier to obtain the financing neededto expand. This is the opposite of how accounting systems are normally operated for tax purposes.To reduce taxes, accountants and business owners often try to show a loss or as little profit aspossible, which allows the business to retain more cash. From this standpoint, perhaps your businessshould be profitable for several years before initiating a growth phase. In many cases, however, youwill not or cannot take the time to accomplish consistent profitability. If you are planning to expandyour business, discuss this process with the accountant who prepares your income statements ortaxes in order to legitimately transfer forward some of your current operating expenses, thusincreasing your current profits.Other ConsiderationsThe time you spend preparing for growth can also improve your business in several other areas,including management. Therefore, you should not implement growth procedures without thoroughlyexamining all aspects of your business operations. Listed below are several factors you shouldconsider before initiating agrowth plan.!Expect that your personal involvement and commitment to the business will increaseduring a growth cycle.!Consider personal sacrifices and the sacrifices of people you associate with,

including family. The rewards of growth can be substantial and, thus, are deemedadequate rewards for these sacrifices.!Expect additional pressure on the time and resources needed to run the business,because it will take time and energy to organize the financial aspects of growth.Before initiating a growth phase, be sure you have the time, adequate personnel and financialresources to complete the process.There Is No One Right WayBefore you look at the different categories of financial management for a growing company,remember there is no one right way or easy method. Accept that you operate in a world ofuncertainty, in which decisions often are made without complete knowledge of all the consequences.This approach can make managing a growing business challenging and rewarding.When financing a growth cycle, seek assistance from professionals who know the process.Assistance is available through consultants, accountants and lawyers and through services providedby the government, such as the U.S. Small Business Administration (SBA) and its resources (e.g.,the Service Corps of Retired Executives [SCORE], the Small Business Development Centers[SBDCs] and the Small Business Institutes [SBIs] listed in Appendix F: Information Resources).SECTION 1: OBTAINING CAPITAL FOR GROWTHDeciding To Actively Pursue GrowthA primary reason for pursuing growth is to increase profit. There are two components that can beincreased -- the absolute dollar amounts of sales or the profit as a percentage of sales. If these twocan be achieved simultaneously, the resulting growth will be very rewarding. A more carefuldecision process must be completed in situations where there is a trade-off, such as betweendecreasing the percentage of profit to sales (through reducing prices) or increasing the dollar volumeof sales (through increasing prices).Reducing prices to achieve growth is a strategy you might not initially plan but must do to sustaingrowth after commitments have been made. By charging lower prices to increase sales, you usuallydecrease the gross profit margin. However, lower prices may result in significant increases in thepurchase quantity, which then enables the business to earn a profit. The same concept, only reversed,can apply to costs. For example, if you increase costs in order to increase dollar sales volume, youstill decrease your profit margin. This latter approach is feasible if you plan to increase marketingexpenditures to gain additional business.Costs also can be increased from an accounts receivable standpoint. A new business activity mightincrease sales by adding customers with poor credit ratings, thus resulting in a higher accountsreceivable cost. Many managers of unprofitable businesses believe the solution to their problem is togrow in order to spread fixed costs over a larger number of units, thereby improving the gross

margin of the business. (A detailed explanation of this concept is provided in the sectionDetermining the Break-even Point.)Understanding Financial StatementsThe balance sheet, income projection statement and the monthly cash flow projection of funds arethe statements used to manage and report a business's financial operation. The balance sheet andincome statement will be explained in this section. The cash statement is not always completed asthe checking account register provides the same information except that it isn't summarized bycategories.The balance sheet and income statement contain meaningful information about the business. Thebalance sheet indicates the value of the business at a given point in time and is usually prepared forthe end of a typical reporting (or accounting) period. The income statement covers a period of time(month, quarter, year) and indicates the level of profit or loss based on sales less expenses.(Examples of a balance sheet and income statement are included in Appendix A.)Balance SheetThe balance sheet provides a summary of the owner's net worth at a given time. The first section,labeled assets, usually appears on the left side or at the top of the statement and includes thebusiness's assets in declining order of liquidity. The right side or lower portion lists the liabilities andthe owner's equity or net worth. Liabilities include all commitments or contractual agreements to bepaid in the future. Examples of liabilities include loan principal balances and accounts payable(money owed for goods or services already received). The owner's equity is the asset value thatactually belongs to the owner. In a corporation, this is usually divided into original capital andretained