Should your business aim for profits or growth?
The ultimate financial objective of your business should be to maximise profits.
However, in the early stages of your start-up, you have to focus your energy on growing your business in order to take advantage of business opportunities in the future.
Growing your business means investing in resources (such as staff and equipment) that will allow you to generate profits in the long-term.
But in the short-term, these resources are expenses that will reduce your profits.
This leads to the ongoing tension between growth and profit; between short-term pain and long-term gain.
So at what point should you stop investing in growth and start maximising your profits?
The answer should come down to three key considerations:
- How large your business opportunities are.
- The amount of capital available to your business.
- Your mindset and personal finances.
Your business opportunities
If your business opportunities are large and scalable, then you should invest to capitalise on them. However, you need to make sure that you continue to validate your assumptions about your opportunities and market size.
You also need to keep track of how you’re performing against your targets and key financial expectations. If your targets are not being met, stop investing.
This is subject to you having enough capital available, when you need it, to meet the investment and timing requirements to scale-up.
These capital requirements could be substantially more than you initially estimated.
For example, if your target market is changing quickly and you have a number of competitors, you may need to invest large amounts rapidly to establish your market position and get your business to a point where it is self-funding.
Growth requires capital. Sometimes you need to invest a lot of it in order to grow.
This capital can be generated internally from your profits. It can also be raised externally by issuing equity or obtaining debt.
The best position to be in is where you can rely on your profits to self-fund your business needs. Self-funding means you don’t need to dilute your ownership (as you do by issuing equity), or risk borrowing and not being able to meet your repayments (as you do when you obtain debt).
However, your start-up may not be able to generate enough cash in the timeframe required to capitalise on a business opportunity.
And while there are control and risk issues associated with the alternatives, you need to weigh these issues up against the potential returns you might miss out on if you don’t pursue a business opportunity.
Australian small business owners are typically more reluctant to give up equity in return for capital than many of our counterparts on foreign shores.
As a result, we often end up owning 100% of a small pie, rather than a small slice of a much larger one.
To be able to grow and scale your business at a rapid rate, you need to have an entrepreneurial mindset. You also need courage to take risks and to sacrifice short-term profits to pursue a bigger, better, but uncertain future.
Many small business owners will grow their business to a certain point, and then curtail further investment for the relative safety of small but steady profits.
They either lack the confidence, skills or information required to grow their business beyond that point.
That point is generally when the business grows to a size where the owner can no longer have direct control over all aspects of the business.
I have even seen owners shrink their businesses so that they can stay within their comfort zone and retain direct control.
In order to relinquish some of your control, you will need to have accurate information on hand to keep track of how things are going in your business. You will also need support around you to properly assess and capitalise on your opportunities.
Finally, personal finances are a common reason for business owners curtailing their growth.
Your financial circumstances may dictate that you need to start drawing cash from your business.
This will leave your business less money to fund growth. Just like the tension between growth and profit, whether you reinvest your profits or not is another decision you need to make.
And it’s a decision that can have a substantial impact on how you feel about your business and its performance.
Just as you need a capital funding plan for your business, you also need to plan your personal finances and assess whether your business can afford you.
Marc Peskett is a director of MPR Group, a Melbourne based firm that provides business advisory services as well as tax, outsourced accounting, grants support and financial services to fast growing small to medium enterprises. MPR Group is a member of the Proactive Accountants Network. You can follow Marc on Twitter @mpeskett