What is the key to growing your business without exploding?
A large proportion of businesses fail when they are in a growth phase. The main reason this occurs is a severe lack of planning resulting in no cash in the bank to pay expenses. These failed business managers don’t know how to say no to the kind business that they cannot afford to take on.
Planned Growth – The Key
Obviously, to enjoy growth, cash is mandatory. Therefore, a company must plan its growth because unplanned growth can result in major cash deficits and risks. Often, the top management team (that means you small business owner) in the company assumes that for sales growth, since the company needs cash, sales must be increased and customers will pay, after which the cash problem will disappear.
This line of thinking might work in temporary situations where you might sell more from your inventory without immediately replenishing it (assuming you can do this), offer your best customers better payment terms (this boosts sales, but can have a negative impact on cash flow as more and more money becomes tied up in your receivables book), get better deals from suppliers etc. for specific projects. But none of these things is a solution since they all actually result in harming the business’s cash flow.
Ideally, with planned sales growth, existing operations must proceed smoothly so that the expansion is seamless.
To manage properly, the management must be able to work out the kind of sales growth that the business can sustain within its existing cash profit and debt liabilities. In the absence of such foresight, the right sales targets cannot be set. Either the forecast is too low or too high, affecting the business negatively.
Linking Sales Growth And Cash
We can link sales growth to its ability to generate cash through breakeven analysis so that this in turn can be reworked to align with the impact of cash on growth. Breakeven is basically the point where expenses equal revenue, and where there is no profit, no loss. This means the gross margin is perfectly offset by the operating costs and financing expenses. Since there is no profit, the business does incur income tax either.
In breakeven analysis, fixed costs and variable costs are taken into account. Fixed costs do not change, no matter how much sales takes place. Fixed costs could be rent, utilities, wages, depreciation and cost of long term finance. Variable costs, on the other hand, change with sales volume. This means direct product cost, commissions on sales and delivery expenses. Another thing is contribution margin, where we look at the percentage of the sales dollar that goes towards fixed costs and profit. In breakeven analysis, you can also forecast the sales volume required to take care of associated costs.
Maintaining Sales Growth
If sales growth is very rapid, it puts undue pressure on the business’s financial structure, sending leverage ratios to risky levels. Thus, sales growth must be planned since it affects cash in a big way. Sustaining sales growth takes a lot of planning as it means looking at the business’s ability to generate cash without increasing its debt, since this means even more risk. Because of this, the business might incur more interest charges since suppliers and lenders might manage their receivables based the increased risk. This could place constraints on the inventory, getting in the way of production and merchandizing. The business may also have to sacrifice some margins.
By ensuring that financing is managed properly, risks can be minimized. By maintaining steady and consistent sales growth, you can achieve a balance. This is based on the assumption that the business’s ability to use assets efficiently is constant, along with its efficiency in operations, financing, taxation and net profits. Along with this, the dividend must also be consistent. Thus, steady growth means ensuring that there is no shortage or excess of cash. The business’s cash balance is in proportion to the sales, assets and expenses incurred.
Rapid growth that is outside the sustainable rate will naturally need more cash than when in a steady state. Obviously this extra cash must be generated and this could be sourced from reducing dividends, borrowing more than before, raising net margins by lowering unit costs, raising prices, improving asset efficiency – as all of these are cash generators. Top management in the company must look at fresh options that can increase sales growth in a balanced way. The actual growth rate can be sustained by making sure that everyone in the company extracts the maximum from assets and expense, increasing value simultaneously. This can be attained by understanding cash flow dynamics.