Opinion
23 Feb 2015 07:00am

How growth can affect cash flow

Growth is desirable for many businesses, but growing beyond your means can have damaging effects says Ivan Lavelle

Ask any small business owner what their top priority is and you’ll likely hear one word more than any other: growth.

Growth is one of the most highly valued characteristics of any successful company, whether it’s a small startup seeking investment from venture capitalists or a large, publicly traded company aiming to maximise its stock price for shareholders.

In fact, investors often use growth as a reason to amplify a company’s valuation. So-called growth stocks trade at a significant premium due to their future potential, even though they usually don’t pay dividends to their investors.

While growing your business quickly can be a good thing, there are situations in which growth can actually have a negative effect on your company’s viability and cash flow, leading to serious problems that might not be immediately obvious.

Rapid growth is often volatile and unpredictable

Most entrepreneurs have seen the ‘hockey stick’ growth charts of companies such as Facebook and Google. These charts depict rapid, exponential growth, both in the amount of customers a company has and its total revenue.

Some businesses can support rapid growth. These businesses are typically software or technology companies that have a highly scalable product that can grow without its costs growing at the same pace.

Volatile, rapid growth [...] can be a serious risk if your business model doesn't allow for profits to scale at an exponential rate

While this type of volatile, rapid growth might be desirable for these companies, it can be a serious risk if your business model doesn’t allow for profits to scale at an exponential rate without a similar increase in expenses.

If you need to hire staff to deal with rapid growth in the volume of accounts you’re dealing with as a service business and many of these accounts subsequently leave your company, your expenses could soon become greater than your income.

Likewise, a quarter of extremely strong sales growth could encourage you to expand your sales team, only to be followed by a subsequent quarter in which sales aren’t as great as you predicted.

The best growth is stable, steady and reliable. Not all businesses can afford to grow rapidly – if your business model depends on stability, a rapid growth period could leave you with serious long-term cash flow problems.

Growing too quickly can affect your product’s quality

When your business proves successful on a small scale, it’s tempting to expand it as much as possible in order to maximise its revenue. This often results in the quality of your product – the source of its initial success – decreasing with scale.

A classic example of this dilemma in action is when a restaurant expands from one location to several. Instead of being able to manage operations in all locations, the owner – often the driving force behind its quality – can only manage one.

If your company delivers an experience that doesn’t scale – for example, a bespoke service that’s built around great customer service, or a restaurant that’s dependent on serving only the top quality dishes – scaling can often ruin what makes it great.

In addition to potentially reducing the quality of your product, growing too quickly can amplify the effect of flaws in your business model. A problem that’s manageable when you have 100 customers can become uncontrollable once you have 10,000.

There’s a reason Patek Phillipe & Co. only produces 50,000 watches a year, despite having 2,000 employees – it understands that the selling point of its product is high quality and that increasing its sales volume could negatively affect its quality.

When quality – whether quality of your product or quality of your service – is one of your key selling points, it’s a far better choice to stay small and excel than to grow larger in sales volume and lose your advantage.

Growing rapidly often means borrowing more money

Your company has just recorded its best ever quarterly results. Sales have doubled and your company’s profits are steadily rising. Based on the good news, you double down on your business and borrow more money to fuel even greater growth.

Growth and debt are highly related to each other in business, and as a company gets bigger, the amount it owes its creditors can often increase substantially. With a good business model and healthy risk management, this is rarely a serious problem.

Without sufficient risk management, or with a business model that simply doesn’t work when grown beyond a certain point, taking on more debt to fuel growth can lead to a cash flow crisis.

Management and strategy issues often don’t become clear until your business reaches a point where you need to step back from daily operations. At this point, an issue that seemed small and solvable before can create significant cash flow problems.

When your business grows rapidly – at least on paper – it’s also easier to ignore the warning signs of a potential cash flow crisis. Late payment from a customer isn’t as big of a problem when you’re earning more every month, but it’s still a problem.

It’s tempting to maximise your company’s line of credit in order to make it grow as fast as possible, but doing so can be a serious mistake. When not closely monitored, rapid unsustainable growth – combined with large debts – can cause cash flow issues.

Iron out potential problems before you focus on growth

Growth is an important aspect of running a successful business, but it shouldn’t be your business’ first priority. An intense focus on short-term growth can leave you blind to serious issues that could eventually affect your company’s solvency.

Before you focus on growth, perform an audit of your business to locate and solve any management, product, service or accounting issues that could grow in size as your business expands and develops.

While growing your business also means growing your monthly profits, for many business owners, it means growing their liabilities. By growing strategically instead of excessively, your business will enjoy steadier earnings and greater financial stability.

 


Ivan Lavelle is a director at CorporateRecoveryHelp.co.uk

 

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