Rising Sales are great, right? Read this first
Resurgent Growth easily overtakes Cash Flow!
“If the people knew how hard I had to work to gain my mastery, it wouldn’t seem wonderful at all.” – Michelangelo
These days, one of the things I hear most often in my conversations with CEOs is their confidence that growing revenue and reduced expenses is all that’s needed to restore performance and financial stability. That’s the simple cure to overcome the travails of the last 18 months. “If we can just get back some of the sales we’ve lost and hold down our expenses, we’ll be profitable again and have the cash flow necessary to resume normal operations.”
Financial resources to fuel growth are the lowest in years
Unfortunately, that scenario is unlikely to unfold as scripted. As a result of depleted profits and depressed cash flow incurred over the last 18 months, the financial resources to support revenue growth are at the lowest level in years. What business leaders regularly overlook is that pressure on working capital resources to support renewed sales growth is more crippling in times of growth than in periods of decline. This is exacerbated when business executives equate improved profitability with enhanced cash flow.
Working capital is more constrained during growth than decline
Let’s assume you have a $10 million revenue business with receivables outstanding for an average of 60 days. That means that there is approximately $1.7 million in accounts receivable outstanding at any one time, representing approximately 15 percent of revenue. So, if revenue rises 10 percent and nothing changes in the accounts receivable cycle, accounts receivable will also grow by 10 percent or approximately $170,000. The growth in revenue won’t fund that need – it’s that growth that creates the increase. What resources will carry you while you wait those 60 days to collect the new receivables?
On top of that, you’ll need more inventory to fulfill those additional sales, always the most perilous component of working capital. While accounts receivable will grow as sales are made, inventory will have to grow before sales are made, and as we know, selling inventory in the planned timeframe is about as certain as medieval alchemy.
Where do you get the resources to fund growth?
Again, where do the financial resources come from to support this growth? With the continuing restraint in bank lending resulting from more rigorous oversight by federal regulators as well as the reduced creditworthiness of business borrowers, obtaining those funds will be more challenging than ever. Lenders also know that very few borrowers truly understand their working capital requirements or the full measure of their external financing requirements. Business owners often adopt the shopworn approach of asking for a line of credit greater than they think they’ll require to open the discussions, figuring they’ll ultimately end up with what they really need. Without an objective analysis of the financing needs, this is a sketchy approach that may leave you deep in the weeds at the most inopportune time.
Determine your external financing needs first
The first thing to do is to figure out your external financing requirements and compare them to the existing resources available to support working capital growth. The level of resources available for working capital is generally based on the company’s ability to earn profits and retain them in the business.
The chart above illustrates a comparison of the external financing requirements to available financial resources using the same amalgam of U.S. companies we visited last time. When a significant gap occurs, as illustrated in the chart, the company can expect enormous pressure on its cash resources.
Nonetheless, many companies invariably move full speed ahead to crank up the sales engine even when they haven’t identified the cash resources or obtained the requested line of credit. It’s only later when the sales curve overruns the available resources that the pressure threatens both the banking relationship and sometimes the very survival of the business.
Don’t rev up growth until you nail down your financing
Make sure you get a clear, objective picture of your external financing requirements, as well as your borrowing eligibility and qualifications, before ginning up the revenue curve. Your bank is a welcome ally if you do it correctly but a worrisome partner if your financial resources are stressed and bank covenants are threatened. Do your homework. You’ll need more resources than you expect to turbocharge your sales coming out of the Great Recession.
Lary Kirchenbauer is the president of Exkalibur Advisors, Inc., providing practical business strategies for family and other privately owned businesses in the middle market. Exkalibur works closely with senior executives and their businesses at the intersection of leadership and business strategy and uses the Business Ferret™ framework to help companies use strategic finance to drive improved business performance. Lary also hosts the Exkalibur Leadership Forum for leaders of middle market companies in the North Bay. Please visit www.Exkalibur.com for a library of valuable resources, articles and insights or join the Exkalibur fan page on Facebook.
The North Bay Business Journal, a publication of the New York Times, is a weekly business newspaper which I have served as a regular columnist for more than two years. The Business Journal covers the North Bay area of San Francisco – from the Golden Gate bridge north, including the Wine Country of Sonoma and Napa counties.
Article published – May 10, 2010: The electronic version of this article, as published by the North Bay Business Journal, is identical to this post and may be found here.
Any related materials or articles referenced in the published column, or otherwise applicable, are referenced in this digital version of the article.