…And What Smart Owners Do About It
Who Knew? Growth can kill!
Anyone with even a modicum of business experience knows there are a dozen ways to go under:
- Ruthless competitors
- Losing a key customer
- The founder’s idiot kid takes over, torching the legacy
And at the end of the day, almost all of them show up as cash flow issues.
Digging deeper, consider these two paradoxical realities. They don’t teach these in business school.
You can grow yourself right out of business.
and
If you want your company to actually throw off some cash to the owners…
Slow down the growth.
The Paradox of Growth - Cash Flow Issues Begin!
- Twenty-four straight months of sales growth.
- Double the size you were three years ago.
- People, revenue, energy are all up.
Then why do you find yourself lying awake that same night, wondering if you’ll make payroll tomorrow?
WTAF?
Why is every indicator going up, except your bank balance?
Most of us get that growth takes resources. If you’re already running a lean operation with no idle staff or unused space, then scaling up means adding capacity. That might be more salespeople, another location, more equipment, or extra techs and tools, depending on your business.
And of course, all of that takes money. Time-wise, revenues always lag expenses.
Where the Cash Really Goes
It’s not just fixed assets like vans, and furniture and gear that suck up money. Often we overlook working capital.
That means:
Inventory: You’re stocking up ahead of sales.
Receivables: You’re acting as a bank while customers pay you in 30-60 days.
Float: You simply need more daily cash to keep the machine running.
| Internal | External |
| Reinvested profits: Retaining earnings instead of distributing them to shareholders allows you to fund growth directly from operations. Working capital optimization: Freeing up cash by reducing inventory levels, collecting receivables faster, or delaying payments to suppliers without harming operations. | Debt: Bank financing, invoice factoring, asset-based lending, leases, purchase order financing. Any external funding that will be repaid. Equity: Raising funds by bringing in new investors or having existing owners contribute additional capital in exchange for shares in the company. |
How I Learned about Overtrading
This is an excerpt from my book, The Small Business Operator’s Manual.
This happened about 2003.
I will never forget the day the bank manager called me to tell me that we were doing great, and the bank was pleased to see us growing so fast with such an “A-player” customer list, so therefore the owners would have to put more money into the company.
I was like… WTF?
He explained that as we had grown so quickly, our working capital needs had outstripped the ability of the company to generate new cash. Up to that point, the difference was being made up by a bank loan. But he had decided as of that moment that it was our turn. He said to me, “Brad, we both know you’re overtrading.”
He assumed I was familiar with the term, given that I had an MBA. I was not. However, I was armed with Google (although at that time, it was probably Alta Vista!), so I quickly pulled up the definition: “…the practice of conducting more business than can be supported by a firm’s working capital.”
The bank manager was concerned because when this happens, a company can run out of cash and ultimately go bankrupt. Banks don’t like their customers going bankrupt, especially when they are owed money by them!
I promised to talk to my partners and get back to him, which, by the way, I never did. I never heard from him again about this, but it was a wake-up call to manage cash a lot more tightly for the time being.
And THAT is how I learned what overtrading was!
It’s also how I learned that sometimes you can ignore the bank when they try to tell you what to do (at least until they ask the second time).
Even if you’re not overtrading, fast growth can make it very difficult to manage cash flow. Smart owners understand (and plan For) it. They watch cash like a hawk. They don’t delegate this unless it’s to a highly capable and conscientious individual. Running out of cash means your company comes to a halt.
How do I stay sane (and solvent) and minimize the bite of cash flow issues resulting from rapid growth?
Knowledge is power.
You have to run at least a 13-week rolling cash flow forecast.
This template on my website runs for 52 weeks, but can be used for any time period. You want to know well in advance if you’re going to have a cash crunch so you can manage around it, either by getting customers to pay early or arranging extended terms with one or more suppliers.
Stay tight on your receivables. Treat your collections as critical. Now is not the time to let customers begin stretching you.
Review your inventory levels and consider whether you can reduce them without incurring a significant risk of lost sales due to low stock levels. Inventory management is an art, and an area often neglected in smaller firms. Every $ of inventory you don’t buy is a $ of financing you don’t have to source!
Are your costs, and hence, your margins, optimized? Can you raise prices without losing a meaningful amount of business?
All of these will throw off a bit of extra cash.If you foresee a potentially serious cash shortfall, first look at internal sources of cash. Can you manage your working capital better?
After that, you need to consider either putting extra funds into the company personally or obtaining bank or other financing. As a short-term option, factoring or accounts receivable financing might work. They’re a bit expensive but very flexible and relatively easy to set up if you have high-quality receivables (not aged; good customers).
Pro Tip! Any $ you put into the company should be recorded as a shareholder loan. If you have a bank loan, they may push you to put in equity. Resist.
Another Pro Tip! Resist any ideas you might have about selling shares to an employee to solve a cash problem. This post and my book both provide more detailed explanations of why this is a bad idea.
What not to do:
Don’t offer prepayment discounts. The cost of the money is too high. This will be covered in a future blog post, so please look here for a more detailed explanation.
One final “watch out”
High growth can be a lot of fun, and if managed well can literally transform your business by taking it to the next level in your industry. But high growth has to be accompanied by healthy margins. Thin margins + fast growth = bankruptcy waiting to happen
Cash flow issues are a part of any business. Consider sleepness nights a rite of passage for the serious entrepreneur. And take some comfort in this widely-cited quote, of unknown origin:
“Revenue is vanity, profit is sanity, but cash is king.”
Want to Actually Take Money Out of the Business? Slow Down!
As we’ve seen, if you’re growing fast, the business will consume every dollar it makes and then some to fuel that growth. You might be showing solid profits on the income statement, but that cash is likely tied up in inventory, receivables, new hires, equipment, or facility upgrades. Growth reinvests your profits for you, whether you like it or not.
If you want to actually peel off cash for yourself or your partners, you need to slow down growth, at least temporarily. Once you stop feeding the beast (no new fixed assets, no working capital expansion), that cash starts accumulating in the bank.
Now, your business is throwing off real, distributable cash, not just paper profits.
Get Brad’s free Cash Flow Planning template (Excel) and start washing away your cash flow issues.
If you need help getting your cash flow under control, reach out and let’s talk.
