Entrepreneurs and small business people like to think of themselves as being innovative and oriented toward growing their companies. Sometimes, however, they’d benefit from a broader understanding of and some better tools to manage one of the most fundamental aspects of growth – enough cash to get their growth engine started and to keep it going. As with many other things, it’s easy to say “I just don’t have the time” to focus on this right now; but cash flow difficulties usually appear when you really don’t have time to deal with them, so planning ahead for the fast growth you want makes sense.
We could get into some pretty heavy stuff when talking about properly managing cash flow and you’ll likely have to do that at some point. The purpose here, though, is to highlight what happens to cash when a business experiences fast growth, why growth often leads to unforeseen cash problems, and a few things you can do about it.
The most important thing about managing cash flow is to never be surprised by what will happen in the future. This becomes critically important when a business is experiencing fast growth. However your small business does it, you need to be able to look down the road and know with some certainty what is going to happen to the cash position of the business under any foreseeable circumstances.
Some of us tend to be “linear thinkers” – in other words, we extrapolate in proportional terms where we are today with where we are going in the future. Such proportionality, however, is rarely the case when things are changing – including figuring out how your small business is going to fund accelerated growth. Change almost always results in the disruption of relationships – whether you are changing slick cash loan offers cash advance online same day something in your personal life, or your business, or its financial structure. Old relationships and cause / affect scenarios fade and are replaced by new ones. Why would you ever think that funding fast growth is any different?
The Impact Of Growth
In general, four things happen to a business’ cash flow, when it grows. The first is that its cash flow, or cash conversion cycle lengthens. Simply stated, this cycle is the timing difference between when a business has to pay its debts and when it will collect the cash it is owed to make those payments. Before you can build more of something, or provide additional services, your business goes through an expansion of its resources – it has to buy additional inventory, spend more time in the field with customers, possibly hire and train more people, etc. to prepare for the increased activity. Then, after the sale occurs, it goes through an expansion of its receivables and has to wait to cash in on the sale it has made. So, as you move to the next higher level of activity, you have to lay the money out up front and will need the cash on hand to do it.
Second, when you are growing, this becomes an accelerating and self-perpetuating cycle. You don’t catch up; things keep getting worse and you need an ever increasing amount of cash to support the growth. If the sales gains are coming quickly, you are collecting cash based on the previous level of sales – you haven’t collected (or maybe even generated) the receivables from the higher level yet, but you have incurred the production costs to “build” whatever you are selling.
For example, assume that $50m of cash on hand would normally support an annual sales rate of $1mm – in other words, a cash / sales ratio of 5%. When your annual sales rate moves to $1.2mm, you need $60m in cash to maintain the same relationship; then its $70m if sales go to $1.4mm. And these numbers assume a linear relationship between sales and the cash you need to support it. Again, this rarely happens. During the growth period – when things are changing – you just won’t be able to operate as efficiently and your business will burn through proportionally more cash to support a higher level of sales, at least for a while.
Third, when a business is growing, there inevitably are things happening that affect its natural “economies of scale” and “diminishing returns.” You may benefit from improved economies of scale, for example, because you can buy inventory at a quantity discount. On the other hand, you may well see diminishing returns from your employees, because they can’t work as efficiently at a higher level of activity, or because you have to hire new employees and give them time to come up to speed.
Finally, the margins of the business are likely to change in a fast growth scenario for a variety of reasons. If you are selling a new product, or service to generate the growth, or changed your pricing to get the business in the first place, or need to change your overhead structure to handle the increased activity, or need to hire inexperienced people, margins will not be the same as they were at a previous activity level. This affects cash levels, because, ultimately, the profits that you generate will turn into cash (if the owners leave them in the business) and lower margins mean proportionally less of it.