When Should You Expand?

Congratulations on even having to answer this question. If you are in this position, you have done a number of things correctly. First, you have been able to successfully start a business and develop it to the point where a second or expanded location is a question that you must address. You will find that some areas are much easier with the second location and others are much harder.

First, let us take stock of your present location. The following questionnaire may be helpful:

I have developed internal systems of operations. Yes / No

I have on staff a person strong enough to replace my every day contribution to the operation. Yes / No

The company generates income in excess of what I must personally remove from the business. Yes / No

The present location is operating in excess of 75 percent of capacity. Yes / No

The above questions are best answered with a yes. By having people and tight procedures in place, you are going to be able to remove yourself from enough of the day-to-day operations to be able to devote yourself to the new location. The second half of the questions deals with the financial considerations. Will the first operation throw off enough cash to support the start-up period, and is the present location not under-utilized? It may make more sense to strengthen the present location before you venture into the next one.

Assuming your house is in order, let us next examine the basic financial considerations in making this decision. The following is a basic set of tools you will need:

1) Monthly financial history of your present location from start-up to present.

2) A summary of initial capital required by the first location broken into the following categories:

  • Equipment
  • Leasehold improvements
  • Initial supplies and inventory
  • Start-up staffing costs
  • Working capital

The first tool will give you an excellent idea of how the operation will develop once it is open. You have an established growth pattern to draw from and you are also able to estimate costs as they will occur. This was a luxury that you did not have in your first start-up.

The second tool also gives you an edge. By knowing how much equipment will be required, along with other costs of the pre-opening time frame, you will have a good understanding of how much capital is required to launch your second shop. The working capital amount can be calculated by working out how long the first location took to be in a positive cash-flow position.

Now you can start the development of estimated cash flows for the second shop. Using the historical data you have, along with knowing how not to make the same mistakes the second time around, estimate how much money and time is required for the second location to stabilize.

To do this, setup the following simple work sheet:

By doing this you have effectively created a cash budget for the new operation. You also have something to present to your banker when it comes time to borrow the money. Finally, it will give you a good idea of what to expect in terms of your own financial contributions to this new venture.

Another consideration is the cost sharing between the two locations. While inventory, for example, needs to be in both places, the storage may be centralized. Labor costs will not be dramatically reduced, but you will have some flexibility in temporarily transferring some support staff between the two locations. Equipment costs, utilities and the like tend to have no overlapping benefits, while areas such as advertising and printing can be easily shared.

On the whole, be careful not to over-state the benefits of two locations. The second location will also cause some costs that a single location does not have. An example of this is the increased management time to control the two locations. Another will be the increased wage costs as you promote another individual to a manager level. Finally, the basics of cash control become even more important when you are not always there to watch that cash register.

Look to yourself as well. Your methods of management will have to change. Decisions will now have to be made not based on direct observation, but rather through third-party reporting. If you have been at all casual about your accounting and financial reporting, this must end. Stricter policies of cash handling and management will have to be enforced. An example is the area of accounts payable. In the past you paid those invoices because you were there when the goods and services came in. Now you will have to rely upon others to approve those payments.

Expansion into the second location is both dangerous and rewarding. What made your first location great may be your presence. Make sure you have considered this in the move. Also make sure that you have the financial resources to weather the storm of the new location. It will be a cash-flow drain and may take some time to turn positive. There is also the outside chance that there may be a down turn in business at your first location. Plan for these contingencies and have enough financial resources available to stay in there.

When should you expand? When you have the resources on hand to successfully accomplish it. You should expand when you see the potential to create more than what you have now, and you should expand when your original location is running to the point it does not need you every day. The benefits of expansion are increased sales, increased personal equity and a feeling of accomplishment.