This is another offering in my ongoing series on understanding the fundamentals of business as we become better business managers. Remember, fundamentals are like natural laws: they don’t change; they’re the same for everyone, and you can’t succeed without understanding and respecting them. The fundamentals today are all about funding growth.
Consider the following scenario that plays out on Main Street every day:
“Finally, my business is growing,” a small business owner confides to his friend, “but why is it creating so much negative cash?” And then, with that deer-in-the-headlights look, he completes his report, “I thought by now, with increased sales, cash would be the least of my worries. I used to be afraid I couldn’t grow my business; now I’m worried it will collapse from growth.”
This entrepreneur’s lament is one of the great ironies of the marketplace: a small business in danger of succeeding itself right out of business.
Beware Blasingame’s 2nd Law of Small Business: It’s redundant to say, “undercapitalized small business.” This maxim is especially true for fast-growing companies because revenue growth depletes cash in two dramatic but predictable ways.
1. Organizational upgrades are typically required to deliver on the new sales: more staff/payroll, vehicles, technology, etc. And the devil in this detail is that you must fund these new things before the growth ROI has made it to the bank.
2. Selling to customers on an open account – where your money is collected sometime after delivery – is essentially making loans to customers. And while it’s true that vendors may let you do the same, most require less time to pay them than you allow your customers. And the difference between when you pay and when you collect creates a negative cash condition, which will be explained later.
Here are three management practices that are fundamental to successfully sustaining growth. All will be on the test.
1. Sales growth is not completely self-funding.
Only the profit you retain, and the positive cash you generate will help you fund growth. Growth plans must be compatible with the ability to fund that increased revenue. Too often we think the big growth hurdle is getting customers to say yes. But the impact of sales growth on cash flow must be considered before delivering a proposal or bid. You should know if you can fund growth before you go after it.
2. Practice capital allocation.
Don’t buy capital assets, like equipment, fixtures, etc., with operating cash. If you can pay for it organically with retained profits, congratulations. Otherwise, call your banker. If you don’t like to borrow money, that should motivate you to leave profits in the business as retained earnings, which is the best way to reverse my 2nd Law (above). But the only thing worse than borrowing money is depleting your short-term cash to buy long-term assets, which is a shoot-yourself-in-the-foot mistake.
3. Know the difference between your AR Days & AP Days.
If every new business understood the relationship between Accounts Receivable Days and Accounts Payable Days, we could cut business failures in half. As mentioned in the “extending credit” part earlier, it’s almost a natural law that you will pay quicker than you collect. And the difference – measured in cash – between paying and collecting is the cash you must cover with either retained profits, positive cash (this is dangerous to count on), or other sources, like a bank loan. One of the benefits of getting good at this fundamental is that you can’t calculate AR/AP days without accomplishing another fundamental: having a current balance sheet and P&L. So, by definition, you will have produced fundamental financial management reports.
If you lurch uncontrollably to surviving this multi-faceted learning curve to fund growth, as I did, it will become a very powerful “a-ha” moment you will not forget.
Write this on a rock … Growth-funding fundamentals must be monitored for sustainable growth because it is possible to succeed yourself out of business.