07 December 2006

The real cost of expanding – can you afford it?

Australia is going through quite an amazing growth stage and I see many businesses that are in the midst of mirroring this economic growth by expanding themselves. But be warned, expansion costs money and there are plenty of businesses that have gone broke because they have expanded too fast. It’s a hard concept to get your head around – business is great yet we are going broke.

I have a friend who is a photographer and publisher. He runs an extremely successful and profitable business. I remember talking to him one day about how great his business was going. He looked me in the eye and said that his business had never been so vulnerable or under so much financial pressure.

Because his products were in such large demand he had lots of shops that wanted to sell his books around Australia. It was nothing for him to have fifty or sixty new customers per month which in reality cost him about two thousand dollars each to set up. This was putting enormous pressure on his cash flow as it took up to six months for him to recoup his outlay.

There is a general philosophy that businesses should be growing and expanding all the time. It is important to understand that there is a cost to pay for this expansion and you really need to plan your business’ growth carefully at a rate that you can afford.

Of course for many businesses there are cost advantages to expanding such as increased buying power. Sometimes it is simply a matter of necessity to keep up with competitors. My point is that to get to that stage, you either need cash behind you or access to funds to sustain the growth (and hopefully an understanding bank manager).

Another friend of mine who owned a large transport company always said that it was much harder to downsize a company than to expand. The point that he was making is that when you expand you are basing the expansion on increasing revenue from more customers. If for some reason that suddenly stops it is very hard on everyone to shrink the business down to a profitable level. Staff have to be laid off, office size reduced, debt reduced etc.

The main tip that I am making here is that if your business is growing due to demand that is great. But be careful about how you manage that growth and build into your business plan the fact that one day you might need to downsize.

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