Many entrepreneurs feel that fast growth is the best way to build a company. The philosophy of 'Get Big Fast' permeates today's new high-technology companies. Growth implies opportunity, and opportunity makes raising capital easier. So, these companies aggressively raise capital as they grow.
But is explosive growth the best option for a small start-up company, which can't rely upon external sources of funding? Probably not. Success can kill a company as quickly as failure. Even a company that's growing like gangbusters and earning great profits can go bankrupt if cash flow becomes a problem.
To grow your business demands investment. Only a certain level of growth can be funded by internally-generated cash flow. Once your company's growth exceeds that growth rate, you'll be dependent upon borrowed money or equity investment. And, if the banks won't lend you the money or if you can't secure an investor, your company could get into deep trouble by being too successful.
Jay Goltz, author of The Street Smart Entrepreneur: 133 Tough Lessons I Learned the Hard Way, writes: "There's a mathematical formula to determine how much you can grow and remain self-funded. To do that calculation, you first have to figure out how much money you need to invest in your business to generate a sales dollar. As your business grows, you will need more money to finance your inventory, receivables, ...."
Goltz suggests working with your accountant to determine just how much money must be invested in your business to generate each dollar in sales revenue and what level of growth will stretch your company's cash flow to the breaking point.
Consider a small book publishing company. Book publishers frequently struggle with cash flow because of the standard payment terms in the book industry. While most industries have 30-day payment terms, the standard industry terms in book publishing are 90 days. This means that once a publisher sells a book through a distributor, the publisher must wait 90 days to get paid. Many exclusive book distributors even have 180 day terms.
While waiting six months is a lesson in patience, it kills a small publisher's cash flow. Money that isn't received isn't available to print more books, pay rent, pay employees, and pay all the other bills a small publishing company generates. Excessive growth doesn't generate positive cash flow. Rather, it demands more investment.
As an example, assume you're a small, cash-strapped publisher. You sell 10,000 books, with a total cost of $30,000, this month. Assume that you only have $5,000 cash on hand and that you run out of inventory this month.
If you were to receive payment immediately for the books sold, you'd be in great shape. You'd reprint more books, pocket the profit, and be very happy. But, you're waiting for payment.
The next month, you generate 20,000 book sales. Unfortunately you don't have the money for an adequate reprint. The month after that, you generate 25,000 sales. But, you're still waiting for your money from the first sales! Clearly, your company is in trouble. You have orders. but you can't fulfill them because you lack the cash.
In this case, you can't supply product and your profits are hindered. In worst case scenario, your company's growth leads to increased expenses that can't be controlled. You begin incurring costs you don't have the money to pay. Rather than leading to success, explosive, uncontrolled growth leads to bankruptcy.
So, what's a small business owner to do to control growth and improve cash flow?
Companies which generate sales to other businesses via salespeople can stop aggressively adding sales staff and focus upon their existing customers. Know how much money it costs to add a new salesperson to your staff and how long before that salesperson starts to generate positive cash flow. Other companies can cut back on advertising and promotion. Just because you can sell more product doesn't mean you should!
If cash flow is an issue, seek to grow your company in steps. Wait until your cash position is strong before moving to the next growth step. That will help to assure that you can internally fund the growth.
As you're planning your company's growth in steps, take the time to evaluate the systems you have in place. Are your systems adequate to support higher levels of sales? For example, do you have space to store the inventory, enough employees to ship the inventory, and an adequate number of phone lines to serve customers?
Even a non-capital intensive business, such as a software company, can get into trouble with customer service if enough customer support staff aren't available to deal with the demands of growth.
Customers who see a company fall from excellent customer service to poor customer service are likely to go to a competitor. Excessive growth sometimes first shows itself in a company's inability to maintain a high standard of customer service. There's just too much work to be done. Be sure you're adding adequate support staff to maintain quality customer service. And, accept that, as sales grow, you might need to find new and more efficient ways to do things.
Remember, new customers are great, but getting new business is costly. Repeat business from customers served well is the heart of long-term business success and profitable growth. Don't let too many new customers drive away your established customer base because existing customers are no longer being served adequately.
What are your company's key ratios that express inventory as a percentage of sales? How much money is tied up in accounts receivable as a percentage of sales? What is a reasonable revenue per support-staff employee?
Once you understand how your business copes with growth, work to improve cash flow. Invoice customers regularly and follow up on delinquent accounts receivable.
Do not compromise your company's reputation by trying to stretch payments to vendors beyond a reasonable pay period. Just because publishers accept 90 day payment terms doesn't mean it's smart business, or that vendors in other industries will accept similar terms. To protect a company's cash flow, cutting off supply to slow paying accounts is standard policy in many industries.
The only way to pay your bills in a timely fashion is to demand that your customers pay their bills in a timely fashion. Know what is considered "timely" in your industry.
Finally, work with your accountant to create cash flow projections and a realistic budget based upon the realities of your industry and your particular company. That will help assure that your business's growth leads to success, not failure.