Can Rapid Growth Destroy your Business?
by Doc Rich
“Growing broke” is, unfortunately, all too common in the world of small business. Although growth is good, unless the financial consequences are understood and strategically planned for, growth can destroy your business.
If you are not financially prepped for a rapid increase in sales, your business can quickly lose its breath and fall into debt that can hamper normal operations and strangle the life of the business. What seems like “success” on the surface can actually “kill” your company. That’s right – success can kill!
The reason is actually quite simple:
Additional sales require additional assets and these additional assets must be paid for.
Though some of the money to pay for these assets will come from additional profit, since profit is usually only a small percent of sales (e.g., the average small business net profit margin is less than ten percent), the faster sales (and therefore assets) grow, the less likely additional profit will pay for the required additional assets. At some growth rate, asset growth will be larger than incremental profit and the greater the growth rate, the greater the gap.
A basic rule of thumb is that there is a one-to-one percentage relationship between sales growth and asset growth.
For instance, if your sales grow by 20 percent, assets will need to grow by 20 percent to support the additional sales. More sales require additional working capital and can also require extra property, plant and equipment. For example, consider a retailer with five stores each with sales of $200,000 per year. Adding an additional outlet could grow sales by 20 percent. But this action will require additional property (the store) and additional cash for transactions, inventory to fill the store and, if the retailer sells on credit, additional accounts receivable.
Another general rule is that the net profit margin will remain constant as sales grow, leaving a gap between profit and assets.
Also, although sales are growing, costs are also growing. Materials purchases increase proportionally to sales. The growth in sales for some companies means additional shipping and packaging expenses and probably more rent and utilities for additional space needed for assembly, processing and storage. And, to maintain stable operations, additional support employees or management usually is needed. Although profit in dollars will increase, profit as a percent of sales will most likely stay the same.
This gap has to be covered by debt and/or equity. If financing sources are secured prior to the rapid growth in sales so that these gaps can be easily paid for, there is no problem. However, if financing sources are not secured ahead of time, each gap will initially draw down cash balances, and then require the owner to inject additional personal equity capital. It may even lead to factoring and/or predatory lender relationships.
Finally, if not stopped, rapid growth will destroy your firm, causing it to “grow broke.”
So take a deep breath, and get prepped for that big step in sales by using the Sane-O-Meter to see what impact increased sales and increased assets can have on your company.
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