Effective Ways to Financially Prepare for Expansion

Financial preparation is a critical part of any business expansion project. Talking about financial preparation, three aspects that come to the forefront are the financial liability that will arise from a new project, financial ability to execute the project and financial feasibility of carrying out the project.

 

A business expansion project shall increase the financial liabilities (increased costs) which have to be sourced internally and/or externally (revenue generation, loans and borrowings) reflecting the financial ability of the business enterprise to support expansion. The third aspect is determining the financial feasibility (profitability, healthy ROI) of executing an expansion project. The three financial pillars (liability, ability and feasibility) and project financial management are elaborately discussed here to help businesses effectively prepare on the financial front for their expansion projects.

 

Financial Liability

Costs of business expansion are of two types – capital expenditure and direct and operating costs. The capital expenditure includes investments in machinery, equipment, furniture, space, set-up and establishment costs etc. The direct and operating costs include the expenditures to run the new project. This includes the purchase of inventory and raw materials, wages and salaries, rent and bills, repair and maintenance, insurance and legal expenses etc. Capital expenditure and direct and operating costs associated with a project constitute its financial liabilities and have a direct bearing on its profitability. Therefore, it becomes important that a business enterprise makes a detailed assessment of these costs. These costs have to be recovered to create surpluses. While the investment in capital assets may be recovered in a phased and indirect manner, the direct and operating costs have to be covered on the go. Through cost accounting, a business enterprise can get a clear picture of the financial liabilities of a proposed project based on approximate figures and prices.

 

Financial Ability

The financial ability of a business reflects its knack to procure additional capital funds required to establish a new project and generate sufficient revenue to cover the direct costs and operating expenses. Some of the pertinent questions that arise in capital funding decisions are –

 

  • What is the amount of fresh capital required (cost of new assets, other long-term establishment costs)
  • What will be the composition of capital (debt-equity ratio, proportion of self-funding etc)
  • What the potential sources of capital (loans, credit, angel investors, mortgage etc)
  • What are the costs associated with procuring capital from various sources (interest rates, collateral, ease of acquiring funds etc)

 

The second part is revenue generation from the new project to cover its direct costs and operating expenses. A business enterprise needs to prepare realistic revenue projections which will reflect the quantum and frequency of cash flow. Liquidity is a crucial element of financial management in business. Businesses need to maintain a healthy working capital ratio to ensure smooth flow of operations in any of its projects or business units. In the event of liquidity crunch, which may happen because of poor revenue collection resulting from poor sales, credit policies, bad debts etc, operations may come to a halt leading to further revenue losses.

The financial ability of a business reflects its knack to procure additional capital funds required to establish a new project and generate sufficient revenue to cover the direct costs and operating expenses.

Financial Feasibility

The financial motive behind every business venture or a project is to generate profits. After ascertaining the costs and revenue generation capabilities of a project, a business enterprise would be in a suitable position to determine the financial feasibility of a proposed project. Financial feasibility of a project determines its fate as to whether it should be executed or not. If a project is not able to able to generate a healthy and steady flow of revenue, it would not be able to cover its costs. ROI also indicates as to how soon the project will be able to reach its breakeven point. There are hosts of financial metrics used in the financial analysis which includes profit margins, return on equity, returns on assets etc. Ascertaining the financial feasibility involves preparation of various financial statements like profit and loss account, income and expenditure account, balance sheet, statement of sources and application of funds etc based on approximate figures and prices.

Financial feasibility of a project determines its fate as to whether it should be executed or not

Project Financial Management

Once a project is financially approved, the next step is laying down the base of its financial management. Financial planning has been broadly discussed above. The other important areas are identifying the key financial processes, structuring of the finance department/team and design for control measures.

For a new project, the primary financial processes are procurement and investment or allocation of capital funds, regulatory compliances, accounting record keeping and information system, processing of receivables and payables, cash flow and credit management, liaisoning with other departments and audit. Each of these processes comprises of several operations and activities which have to be streamlined and documented. This can be done by developing Standard Operating Procedures or SOPs that serves as a guide map for employees to execute their routine duties while maintaining the rules and standards.

Finance is a sensitive area for any organization or project. Apart from prudence and professionalism trustworthiness and integrity are essential competencies in the members of the finance and accounts team.Adequate control measures are crucial to the functioning of the finance department. Authority, accountability and responsibilities must be clearly defined leaving no room for any sort of ambiguities. Along with finance SOPs, periodical audits must be conducted to ensure that rules and regulations pertaining to accounting, reporting and other processes like regulatory compliance and cash handling are being diligently followed.

Authority, accountability and responsibilities must be clearly defined leaving no room for any sort of ambiguities.

Financial preparedness and vision are vital for any economic venture. Without the financial ability, a business enterprise will not be able to establish a new project and cover its financial liabilities. And even if they can, doing so without sound financial feasibility will render the whole project unworthy or loss-making causing it to become a financial burden on the existing business and operations.

How Can an SME Raise Funds from Public?

In the recent years, the IPO-route has proved to be a huge success for a large number of SMEs in India. In 2016-17 alone, as many as 80 companies came out with their IPOs (initial public offering) and raised a staggering amount of 811 Crores INR as compared to 46 companies garnering 304 Crores INR in 2015-16 through IPOs. The positively affected sectors include media and entertainment, real estate, finance, manufacturing, agriculture and food processing, IT & ITeS etc. This remarkable shift could be attributed to the reform initiatives introduced by the government and regulatory bodies like SEBI and the SME platforms launched by BSE and NSE through which these IPOs were given effect to.

With the advantages emanating from IPO and the availability of suitable platforms, it becomes worthwhile for SMEs aiming for growth and expansion to consider the option of the public offering. In this article, we’ll try to present a quick and a general overview of how SMEs can raise funds from public offering (IPO) so that the readers can have a rough idea about the IPO process.

 

Advance Planning

Advance planning is crucial for the success of an IPO. Firstly, it is very important for SME owners to acquaint themselves with the rules, regulations, and process of IPO as laid down by the concerned governing body. This will help them reduce the chances of procedural hiccups. Secondly, it is important for a business entity to build the right management team who could not only see through the IPO process but also handle the affairs of the company when it turns public. Similarly, there are other important things like the improvement of business processes, PR and investor relations, financial reporting and compliance, record management etc which a business could plan and streamline in advance as a part of paving its way to IPO.

It is very important for SME owners to acquaint themselves with the rules, regulations, and process of IPO as laid down by the concerned governing body

Appointment of Underwriters

An underwriter is usually an investment bank who looks after the administration of the IPO process for its client. In exchange for its services, these investment banks charge underwriting fees or a commission when the shares are sold. Some of the critical tasks executed by underwriters include assessment of the financial management of a company, ascertaining the financial requirements and amount of capital to be raised, types of securities to be issued, preparation of the documents to be submitted to the concerned regulatory body etc.

An underwriter is usually an investment bank who looks after the administration of the IPO process for its client. In exchange for its services, these investment banks charge underwriting fees or a commission when the shares are sold

Filing with the Regulatory Body

Next, the underwriter(s) and the company, working together, file the registration statement with the concerned regulatory body. In India, the regulatory body for the securities market is SEBI. The registration statement comprises of all the necessary information and details pertaining to a company such as its management body, financial statements and reports, various compliance reports, capital requirements and planned use of the capital to be raised etc. The regulatory body then investigates this information for its accuracy and authenticity to determine the eligibility of the company for IPO. It also ensures if all the required information has been disclosed and nothing material has been concealed.

The regulatory body then investigates this information for its accuracy and authenticity to determine the eligibility of the company for IPO. It also ensures if all the required information has been disclosed and nothing material has been concealed.

Red Herring Prospectus

In general English, the word ‘red herring’ is used to connote something distracting or misleading. However, in the securities market, the red herring prospectus is a preliminary document issued by a company to the potential investors to generate the latter’s interest for the IPO and it can neither be distracting nor misleading. The purpose of a red herring prospectus is to attract investors for the IPO but it does not include the offer price of the securities, quantum of securities to be issued and the effective date. A red herring prospectus is not the final prospectus and is subject to changes.

The purpose of a red herring prospectus is to attract investors for the IPO but it does not include the offer price of the securities, quantum of securities to be issued and the effective date

Pricing Decisions and Effective Date

After investigation and scrutiny of the information provided by a company in its registration statement and upon satisfaction, the concerned regulatory body approves the IPO. After allocation of the effective date, the company and its underwriters decide on the offer price of the securities and the shares are finally sold on the stock market.

After allocation of the effective date, the company and its underwriters decide on the offer price of the securities and the shares are finally sold on the stock market

Capital is critical for business growth and expansion. The bigger the business goals and ambitions are, the larger will be the requirement for investments. And to infuse larger investment, businesses must consider bigger resource options like IPO.

How can an Indian SME Attract Investment?

The official records put the number of MSMEs existing in India at over 500 lakhs approximately. The numbers may appear frightening for budding entrepreneurs and other existing SMEs as it may present an exaggerated picture of competition. However, it also needs to be understood that these 500 lakh business units are spread over different states, different sectors, different industries dealing in different categories of products and services. But that does not rule out competition from business either. And one such area of business competition is attracting investments which can be a painstakingly lengthy and tiresome process starting right from its planning, finding the potential investors to actually getting the investors on board. This article will attempt to chart out a few disciplined ways which can help the SMEs improve their odds of reaching out to and attracting investors and investments.

 

Know Your Capital Structure

The capital structure of a business entity mainly comprises of debt, equity or a combination of both. Some of the common debt instruments include loans, bonds and debentures. In equity financing, a company raises funds by selling its shares (ownership interest) to retail and institutional investors. Before seeking out for potential investors, it becomes imperative for the SMEs to first understand their capital structure and their capital requirements. Once they know the nature and quantum of capital requirement, it will help them to identify the doors they should be knocking or the options they should consider exploring like IPO.

Before seeking out for potential investors, it becomes imperative for the SMEs to first understand their capital structure and their capital requirements

Identify Your Potential Investors

To attract investment, SMEs must first identify the potential investors. Potential investors for a business enterprise can include venture capitalists, angel investors or financial institutions that invest or have invested in similar businesses/SMEs in the past. Identifying these potential investors may involve developing some amount of business networking and market research. Knowing and knocking the right doors will save a lot of time, money and efforts for business enterprises seeking investment. It is also important to take into consideration the terms and conditions of investment which may vary from investor to investor.

Potential investors for a business enterprise can include venture capitalists, angel investors or financial institutions that invest or have invested in similar businesses/SMEs in the past

Reflect Your Financial Health

Before taking a decision to invest or not to invest in a business enterprise, potential investors would be very much interested to know and assess the financial health of their investment destination. Although the profit and loss statement and the balance sheet of the recent years is a good place to start off with potential investors would also be interested in other financial aspects of a business entity like fund utilization, revenue generation, sales, profitability, costing, inventory turnover, break-even analysis, financial reporting, accounting standards, credit rating, audit reports, financial ratios etc. Thus, it becomes necessary for the SMEs to be in good financial health to attract investors.

Potential investors would be very much interested to know and assess the financial health of their investment destination.

Keep Your Business Plan Ready

When a business enterprise pitches for investment for its business project, investors would like to know about that project in which the investment would be utilized. Investors would like to assess if the project is viable, would take off and generate the desired or promised returns. Therefore, it becomes imperative for the SMEs to present to the investors a powerful summary of the project feasibility (financial, marketing, operational, logistical, economic, technological etc) and an overview of the business plan to successfully execute the project.

Investors would like to know about that project in which the investment would be utilized, Investors would like to assess if the project is viable, would take off and generate the desired or promised returns

Regulatory Compliance

No prudent investor would put a dime into a business which is not regulatory compliant. Investors would rather park their money in banks that invest in a venture or a project that risks itself of punitive regulatory actions. It increases the risk of investment by many fold times. It is of utmost importance for businesses to invariably remain regulatory compliant.

 

Bring Your Core and Best Team Forward

Investors need to know whose hands they are entrusting their money into; who these people are and if they have the suitable professional background and whether or not they exhibit professional commitment and the desired leadership. Thus, it is very important for the SMEs to bring their core and best team forward to interact and deal with the investors, address their concerns and convince them to make an investment.

It is very important for the SMEs to bring their core and best team forward to interact and deal with the investors, address their concerns and convince them to make an investment.

Demonstrate Exit Plan

There’s no steadfast necessity for an exit if both the owner and the investor are content with the growth of the business, the return on investment and everything else going smoothly. But that always may not be the case. No investor would prefer to put their money into a rabbit hole. In the future, they may seek to pull their investments back if the circumstances warrant them to. Providing an option of exit route to the investors can give them some breathing space and can make them feel a whole lot safer than without one.

Providing an option of exit route to the investors can give them some breathing space and can make them feel a whole lot safer than without one.

In a country with millions of MSMEs, attracting investments can be a daunting task but not an impossible one. Before reaching out to the potential investors, pitching for investment and hoping to attract them, it is important for the SMEs to map their business plan, understand their capital requirements and assess their financial health. At the end of the day, it’s the responsibility of the core leadership team to get the investors on board.