Growing a business

All businesses should strive to grow as much as possible. A business that does not strive to grow will run the risk of losing customers to its competitors and could eventually go into liquidation. There are many forms of growth that a business can use when it is gaining experience and appealing to new customers. These are typically split into internal growth and external growth.

• Internal growth – a business that uses its own resources to grow is displaying internal growth (also known as organic growth). This means the organisation is using money made from sales, loans or shareholders’ funds to finance growth (we will cover financial options next in this unit). By doing this, a business can grow at its own pace and ensure that the quality of service is still very high without having to rely on other companies for success. Some of the most common strategies employed when growing a company organically is to hire new staff, develop new products, improve techniques for manufacturing or change marketing strategies
• External growth – this type of growth will rely on other businesses. The most typical form of external growth (also called inorganic growth) is through mergers and acquisitions with other firms. Instead of using money in a business to invest internally, the company will decide to purchase other businesses in order to expand. This is usually quite expensive to do but will be much faster than internal growth techniques. The other downside to external growth is that it carries more risk as the business is reliant on other businesses that it acquires or merges with

Sources of finance for business growth

When growing a business and moving into new areas of operation, finance is a key resource. Money is needed to develop new products, hire new staff or launch products into new markets internationally. The old business saying of ‘cash is king’ is very true when it comes to growing a business, as having the right finances can be the difference between success and failure when growing a company.

Internal sources of finance

Money can be made within a company. This is known as internal finance and usually either comes from selling assets or retaining profit. Raising finance internally is a great method of getting the money needed to expand as it does not require the company to take a loan. The business will be self-financing and growth will be paid for by the company itself – leading to a more stable business in the long term. The two main sources of internal finance are:

• Retained profits – when a business sells goods or services and makes a profit, it must decide where this money goes. If the business does not require any finance then shareholders will simply divide up these profits and then take this money out of the company. However, if finance is needed to grow, the money can be used to invest back into the business. Money that is retained in the business will obviously be taxable so some of this will go to the government (this is called Corporation Tax). What is left can then remain in the business to either pay off debts, expand the company or build a ‘cash reserve’. This ‘cash reserve’ can be utilised by the company at a later stage if it needs to purchase new materials or premises or if it has to pay off a debt that the business owes
• Sale of assets – most businesses own some assets. These are things like equipment, land, buildings or even other businesses. All of these assets have a value and can be sold on to make money for the business, which is then invested to grow the company

External sources of finance

Not only can money be raised from within a company, but finance can also come from other sources. External sources of finance will fall into two categories: equity or debt.

• Equity (share capital) – the equity of a business is the value of the company itself. This belongs to the owners but can be sold off as shares to new investors who pay money for a stake in the company. Doing this with a private limited company can be quite difficult as the owner will need to find a buyer for the shares. Issuing new shares will raise money that can then be used to invest back into the company and expand. The best way to do this for a business that is quickly growing is to become a public limited company (plc). We will discuss what this means later in this section
• Debt (loan capital) – something that many businesses do in order to expand is to gain money by borrowing money. The obvious downside of this is that the company is taking on debts which will need to be repaid with interest. This will obviously come with a certain level of risk as the business may not always be able to cover the costs of the debt. One type of borrowing is called an overdraft. This is when a business draws money from the bank that it does not actually have (this is done through the use of cheques or electronic transactions). Overdrafts are often seen as a short-term source of finance for a company. Other sources of external finance available to a company will include taking a loan or getting trade credit where invoices are sent to clients which are not paid back immediately. Larger companies can also issue bonds if they need to raise money. These are a little like loans and are typically between 5 and 25 years. People buy and sell these on the bond market which give a fixed interest for the lifetime of the bond

Public limited companies (PLCs)

When issuing new shares to people from a business in order to raise finance, it is easier to do this if the company is publicly traded. This requires the company to be a plc, which means shares in the business can be bought and sold on the stock exchange (a place where shares in businesses are bought and sold). Not all companies are listed on the stock exchange and most companies that are will be very large. A private limited company that is rapidly expanding may decide that the best way to continue this expansion is to become a plc. Doing this is known as ‘floating the business’ on the stock exchange. To do this there are a number of legal processes and formalities that must be completed. However, once this process is completed, it is much easier to raise money through selling shares, and the day-to-day activities of the company will not be affected

Advantages and disadvantages of different types of finance

All of the sources of finance available to a business will have different advantages and disadvantages. There is no one solution that is best for any situation and it may be that different sources of finance are utilised by a company at various times. The best source of finance for a company must be aligned with what the company needs the money for. If a business only needs a small amount of money for a short period of time, then trade credit or an overdraft will be the best. However, for long-term sources of finance it might be best to take a loan or issue share capital in the form of becoming a plc.

A business must be able to assess various things when securing finance for growth. These will include the cost of raising finance, the risk associated and the difficulty of raising the money needed. Costs when raising finance are often pictured as being the interest when taking a loan but this may not always be the case. Other costs can be incurred as new shareholders will be entitled to dividends each year – something that eats into the amount of retained profit the business can keep.

Risks must also be analysed when choosing a source of finance, with the most risk coming from external sources. Using retained profit is often risk-free but selling assets can lead to a company not having the right resources to operate and function efficiently. This risk is quite small when compared to the risk associated with external sources though. These will include the risk of unpaid loans and debts or a loss of control for the current owners of a business when selling shares.

Not all sources of finance are a possibility. For example, a small business will not be able to float on the stock exchange so cannot raise funds in this way. Likewise, it may not be possible for a business to raise money through selling assets if it cannot find a buyer or it needs these assets in order to operate.