Planning for a Major Expansion? Here’s What You Need to Know
1. Prepare a Detailed Pre-Investment Analysis
When planning a new investment or expansion, conduct a rigorous sales, margin and cost analysis in order to prepare an accurate budget for the venture. In addition to having a good understanding of the project’s profitability, it’s critical you understand all the capital needs the project will require.
Spend time understanding your expected margins - the price your products will fetch should be less than what you can expect to pay for talent, raw materials and related overhead. Build in time to lower your cost curve and improve yields. These efficiencies take time to perfect. Realistic margin projections are required for a proper analysis. Don’t fool or guess yourself into a poorly conceived project with overly optimistic margin projections. Homework in this area pays off. Preventing a poorly conceived project is a better result than moving ahead with one.
A common mistake in project planning is underestimating the capital costs. These mistakes come in two phases of the project. First, the project build costs are not estimated accurately and cost overruns occur, sometimes creating more leverage than a project can withstand. Second, working capital needs for funding inventory and receivables are overlooked and the company finds it’s under immediate financial stress once the operations begin. Neglecting to set aside or raise enough working capital once a project is completed can torpedo a project.
As part of their analysis, executives should establish hurdle rates – the minimum required return on the new investment. If they determine that the project can offer a sufficient return after paying off lenders, even in a worst-case scenario, it’s likely worth pursuing. If it seems risky, executives should consider seeking partners to share that risk, help raise capital or supply important know-how. Applying a sensitivity analysis to a project’s margin and cost structure can provide excellent material for a discussion around risk and risk mitigation options.
2. Ensure a Good Start-up Process
The start-up period for any new venture frequently determines its success or failure. Once a company decides to go ahead, it needs to really commit. Too many projects go off the rails due to a lack of focus, lack of resources or both. It’s difficult to pull top shelf employees from everyday operations to participate in projects but they are often the difference in a triumphant or disastrous result. A senior level project champion who has the ability to acquire and direct resources is an important component of project success.
In many cases, employees, who may be critical to a projects long term success, are among the last to know about it. This can create to friction between management and staff. To prevent this condition, managers must communicate the importance of a new project to their employees so they can fully understand the “whys” behind the new venture and work to make it a success.
3. Monitor Progress
Once the project is launched, companies should use good monitoring tools to ensure a smooth transition to full operation. These include closely managing the costs and timelines to keep them on track. Once the venture is up and running, effective monitoring will allow you to quickly address deficiencies. Sound operational and financial benchmarks should be established in phase 1. In phase 3 it’s critical to measure the new activities against the benchmarks. This will provide the best feedback for getting and keeping the project on track.
Oftentimes, new projects are not treated as separate from legacy operation. Neglecting to account for them separately inhibits management’s ability to effectively monitor progress, limiting their ability to understand the changes that could be made to improve on deficiencies.
4. Mitigating Losses
Even with the best safeguards, some projects meet roadblocks and inevitably fail. It’s important for executives to recognize these roadblocks quickly so they can take corrective measures before it leads to financial disaster. Understandably, some companies find it hard to stop pursuing a venture on which they have invested a large amount of fiscal and emotional capital. They may not have even considered the possibility of failure. Using the information prepared in phase 1 can help a company avoid the “sunk cost syndrome”.
Being realistic from the start will mitigate your losses if a project takes a turn for the worst. Knowing when to pull the plug and having a plan in place to liquidate the project can save a company time and money. The keys to a successful expansion or investment are:
- Thorough financial and operational analysis prior to commencement
- Prepare a solid project and operational plan with financial budgets and timelines
- Prepare a sensitivity analysis to determine the risk mitigation needs
- Resource the project with high quality staff
- Measure performance to plan often and timely enough to make critical adjustments or decisions
When operating, account for the activity separately.
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