Written by MO.com Subject Matter Resource, Ruth King
Fast growing companies can easily grow themselves out of business, even when they are profitable. What does it take to grow profitably and stay in business? This article explains how your company’s profitable growth can cause your business failure.
First, how do you grow a company out of business? If your products and services aren’t profitable, then the faster you grow the faster you grow the company out of business. It’s critical to ensure that each product you sell or service you provide is profitable.
If your products and services are profitable, the faster your company grows, the faster the company can still grow out of business…even if your company is producing products profitably.
How can this be? Actually it’s quite easy. As a company grows, having sufficient cash is critical. The rule of thumb is for every $100,000 in additional revenues, you need a minimum of $10,000 in cash to support that growth. Companies who sell people-intensive services rather than physical products, such as consulting companies, may need more than 10% of the growth in cash. For many businesses, a company that plans to add $1,000,000 in revenues in a year, must find at least $100,000 in additional cash to support that growth.
Where does that $100,000 go? A growing company usually needs more employees to produce the products and services that ever increasing customers are demanding. So, it makes the decision to add revenue producing employees to satisfy the customers’ demands. Yet, when these revenue producing people are added, overhead personnel to support the revenue producing employees are needed. They may be warehouse personnel, financial personnel, receptionists, and other office personnel. The unfortunate reality is that the revenue producing personnel can’t produce the revenues without the additional overhead support. That’s where part of the $100,000 goes.
Other parts of that $100,000 may go into additional inventory needed as well as higher additional accounts receivable balances.
If you wonder where your cash went, look at the difference in your balance sheet at the beginning and at the end of your fiscal year. Is your inventory balance higher? Accounts receivable balance higher? Accounts payable higher? Look at your profit and loss statement. Is your overhead higher at the end of the year than at the beginning of the year? That’s where the $100,000 could have gone.
How much cash on hand do you need? That is a personal choice based on your tolerance for risk. Some business owners want at least six months of overhead expenses in the bank at all times. Others want six weeks payroll in cash in the bank at all times. Your risk tolerance will tell you how much cash you need to sleep well at night.
Even if you have sufficient cash in the bank, you must continually monitor your cash position. On a monthly basis, look at your financial ratios to ensure they are trending the right way. (See Keeping Score: Financial Management for Entrepreneurs. If you need a free copy email me: email@example.com).
Small changes mean a lot. For example, if your receivable days increase by only five days, that is an additional week before you get paid. I’m sure that your employees won’t wait an extra week to get paid. There goes your cash.
Ensuring you stay profitable as you grow means watching your ratios and your cash each month.