Sin number 8 - Not understanding your self-financing growth rate
By Greg Carroll
Generally to survive businesses need to grow. By being larger and having more customers we are less vulnerable to shifts and changes in the market. But growth costs money to fund. As your business grows you may require new premises, more staff, and more equipment. Most businesses would be seeking to fund this growth from the profits of the business, but there are limits on how fast a business can grow using this source of funding alone.
Think about the operating cash cycle in the previous chapter, this highlighted how much cash the business needed to hold just to survive from one sales cycle to the next. Therefore the cash available for growth will be current cash in the bank plus cash generated from the sales cycle less the amount cash consumed during the sale cycle.
EXAMPLE
We are a distributor. Our gross margin on sales is 30%; our net profit margin is 5%. Our sales cycle is 60 days. Below are our figures for last month.
|
Sales |
$100,000 |
|
Opening stock |
$0 |
|
Plus Purchases |
$70,000 |
|
Less closing stock |
$0 |
|
Cost of good sold |
$70,000 |
|
Gross profit |
$30,000 |
|
Less operating expenses |
$25,000 |
|
Net profit before tax and interest |
$5,000 |
We have just had the opportunity to secure a large contract which could double our turnover. To deliver on the first order we need to purchase $70,000 in stock. But based on the above example the businesses ability to raise additional funds is only $5,000 (Net profit) every 60 days or essentially $30,000 a year. Therefore unless the business has access to additional funds it would not be able to fund this growth.
The important message here is to understand that if your business grows rapidly it is likely you will need to seek funding external to your business. Therefore if part of your initial planning involves a strong growth you equally need to have a strategy of how you are going to fund that growth or your plans will quickly unravel.
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