Adjusting your margins vs. raising equity — which is the better way to boost cash flow?

When your business (or your client’s) needs to increase their working capital, there are options to help accelerate your cash flow.

 

Keeping profits from eroding is a tough proposition in an era of rising interest rates and persistent inflation. For many business owners, the struggle to keep up with the cost of inputs from energy to supplies can often be overwhelming. 

At the same time, healthy working capital is a must for companies seeking to weather tough economic times or follow through with their growth plans.

A recent study found that companies expect to continue facing supply chain issues, rising inflation, and the increasing cost of inputs and employee hiring and retention. In fact, nearly half of the surveyed businesses expect their operating expenses to increase, and 30% expect their profitability to decrease.

Nearly 30% of businesses planned to increase prices to respond to these challenges.  This number climbed to 50% of hospitality and food services businesses.

 

Did you know? According to one survey from late 2022, nearly one-third of companies cited a low cash flow position as a main barrier to achieving their business objectives.

 

To respond to this challenge, some organizations decided to develop new markets, increase sales, reduce expenses or seek alternative financing.

Indeed, rising above financial challenges in this economy — and continuing to meet your goals, pay staff and even grow — means finding a way to free up additional cash flow.

For many companies, this means increasing profit margins or seeking financing. Depending on your growth plans and financial situation, finding the right path will look different for each company.

Adjusting profit margins to unlock capital

Adjusting profit margins is one way businesses can unlock working capital. Often this is done by:

• Increasing prices
• Reducing expenses
• Extending the value of existing customers and relationships

 

Three ways to calculate profit margins Before adjusting your profit margins, it’s important to look at the different ways of measuring profit in a business. These include:
Gross profit margin: Your gross profit margin measures your company’s revenue after subtracting expenses (essentially the cost of goods sold) from your sales.	Gross profit margin = (revenue – cost of goods sold) / revenue
Operating profit margin: Your company’s operating profit margin will show how much revenue your business makes after subtracting the following variable expenses from your net sales:  The cost of goods sold Depreciation, amortization and selling General and administrative expenses like salaries, rent and R&D costs	Operating profit margin = operating profit / net sales
Net profit margin A business’s net profit is what is left after expenses are deducted from total revenue. This is expressed as a percentage – for example, if your net profit margin is 20%, you’re left with 20 cents out of every dollar of revenue.	Net profit margin = net profit / total revenue

What do these calculations reveal?

 Each measure of profit margin tells a different story about your business and where you might be able to make changes that generate results. 

Gross profit margin will provide a window into your company’s efficiency and the relationship between costs and profitability. Operating profit margin gives you a look at the revenue your company generates from its operating activities. Net profit margin will ultimately show how profitable your company is — and help you evaluate its overall financial health.

 

Raising equity — another way forward

While evaluating expenses is a good way to ensure efficiency, continually adjusting margins isn’t the right choice for every business.

As McKinsey explains, even though it may increase profits, excessive cost-cutting can be counterproductive at a certain point. Being too aggressive, such as laying off staff or using lower-quality supplies, can eliminate new sources of growth and may affect areas that previously benefited customers or your brand.

Similarly, raising prices may increase your profit margin per customer, but some customers may not be willing to pay the difference. Finding the right balance between the number of paying customers and the price they’re willing to pay is delicate. 

For example, if 100 customers are paying $1,000, but only 80 customers will pay $1,200, your revenue will be lower even at a higher price. Of course, if you see higher expenses to acquire and service those additional 20 customers, the math may work in your favour. 

If you’ve already calculated the optimal price and minimized expenses appropriately to maximize revenue, further measures to increase profit margins aren’t always possible

Another way to create cash flow is to consider raising equity in your business. Equity financing isn’t a loan you’ll have to repay but rather a way of raising capital for your company. It gives shareholders a percentage ownership of your business and profits. This is often done through venture capital, private equity, angel investors, crowdfunding or an initial public offering.

Raising equity is a popular option for start-up businesses that don’t want to take on debt. A company experiencing significant growth and expansion could be an attractive opportunity for potential investors. 

For organizations with a long-term growth strategy, choosing to forego debt allows you to invest more of your cash flow in the business, rather than making loan payments. The right equity partner can also provide mentorship, advice or networking opportunities from other investors and contacts.

An alternative solution for boosting cash flow

If you don’t want to give up ownership of your company, and you’ve adjusted your margins as much as possible, what can you do if you need to accelerate your cash flow?

You could seek funding from traditional sources, such as a bank, but this strategy is becoming increasingly difficult as financial institutions tighten their lending criteria and interest rates remain unstable.

With alternative funding options, such as invoice factoring and asset-based lending, you can leverage the power of your outstanding invoices and company-owned assets to inject your working capital with a reliable source of cash. You’ll not only access the funds you need quickly, but you also won’t need to give up equity, cut costs or raise prices.

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Discover how Liquid Capital can help you or your client access the working capital needed to achieve greatness. Contact a Liquid Capital Principal today.