Can Too Much Growth Be a Bad Thing?
I recently attended a two day class on financial management for small businesses on the recommendation of one of my colleagues. I was a bit skeptical at first as to how much I would really get out of it (thanks to years of uninspiring continuing education classes), but I must say that I learned quite a bit in this class about the struggles that many small business go through. One takeaway, in particular that I found interesting was the concept of a business “growing itself broke.”
A surprisingly large number of product-based small businesses go out of business not because of a lack of demand for their product, but because there is too much demand. How can that be? When sales continue to grow at a rapid rate, profit margins often go toward stocking up inventory for the next round of sales orders rather than padding the company’s cash reserves. Cash flow concerns may further be exacerbated by payment terms between customers and vendors. For example, if accounts payable is being paid in 30 days on average but receivable collections average 60 days, inventory costs will drain your cash flow much faster than your sales will replenish it. When this happens, the company may be ill-prepared for the increases in expenses that go along with a growing business, such as hiring additional employees and renting additional office or warehouse space.
So how can you grow your business without falling victim to these pitfalls?
1) Carry as little inventory as possible. This will reduce your need for warehouse space and shorten the amount of time between paying your suppliers and receiving payments from customers.
2) Negotiate payment terms with vendors and customers. See how flexible your suppliers are willing to be. If you have an issue with timely receivable collections, consider offering a discount for early payments.
3) Get financing. A line of credit can help you manage fluctuations in inventory and allow you to maintain cash reserves while you wait on your receivables collections.
4) Pace yourself. It may be difficult to turn down large sales orders, but you may need to put a cap on annual sales if you can’t get a line of credit big enough to handle your inventory fluctuations. It might be better for you in the long run to aim for 20% annual growth rather than 100-200%.
The important thing to remember is that while rapid sales growth sounds like a good problem to have, it is still a problem if you don’t have a plan for managing it.
About the Author
Tim Peters is a consultant with Morrison, working primarily in our Business & Accounting Advisory practice. To get in touch with Tim, please find contact information for Morrison here.