The Curse of Growth
“Control your own destiny or someone else will.” — Jack Welch
Hope everyone had a Happy Halloween; in that spirit, how about a tale of horror?
Imagine we’re running a business together (let’s say it’s a cleaning business) and we have ambitions for rapid growth over the next few years.
Starting with some assumptions:
- To get started, we borrow $500 at 10% interest leaving $500 cash in the bank
- Each cleaning crew produces $560 annual revenue and costs $420 per year
- Each crew needs to carry $100 of supplies on average
- The plan is to expand to 15 crews within the next 5 years
- Customers pay us in 60 days on average
- $50 of annual overhead per crew
Here’s my question to you — will we run out of money before hitting our growth goal?
I’ll give you a minute to do some math…
Before I reveal the answer, let’s get to the point of this exercise
Growth consumes cash.
Unless you have a rare business model with negative working capital, this rule is universal and applies to all businesses. Service, product, manufacturing, distribution, it doesn’t matter.
Why is that?
Rapid growth requires front-end investment with back-end cash collection. We have to buy inventory, supplies, pay employees, get a bigger warehouse, etc. And we need those things before we can make the next sale. On top of that, sales are collected later, usually a few days to a few months later.
So we’re on a perpetual treadmill of pay now, collect later.
Back to our growth question
Remember, we started with $500 in cash. When we hit our target of 15 cleaning crews by year 5, we’re down to $140 in the bank despite $1,300 in profit that year!
We didn’t hit zero, but we certainly feel broke. What gives??
[Note, in this example: Cash = beginning cash plus profit minus A/R increase minus inventory increase]
To support our (much) larger business by year 5, we had to build $1,400 of A/R and $1,500 of supplies. Even though revenue, profit, and margins were growing each year, we were outlaying increasing amounts of cash to fund these assets.
This is the power of growth capital and it’s scary stuff!
So what can you do about this?
First, start monitoring some key indicators:
- Receivables growing faster than sales
- Inventory turning slower
- Payables lagging but not enough to offset
- Constant reliance on line of credit draws
- Low or negative operating cash flow despite profit
More sales and more profit won’t solve this growth problem 100% of the time. If your plan is to grow fast, then you need to plan for additional capital along the way.
This is particularly important for newer, less established businesses that are trying to achieve adequate scale.
Last, we’re only looking at the financial side of this equation. Remember, as you grow you’ll need to onboard more people to your team, create processes, and manage a larger group of customers. Those operational challenges don’t always show up on the financials (when they do, it’s usually through too much overhead).
Aside from raising enough capital to grow, the only way to truly manage this situation is to grow within your means.