A Growing Business Also Creates More Risk
Many business owners have multiple opportunities but a combination of fear and uncertainty, a lack of knowledge of how to do it and the related financial implications, as well as a lack of finances, prevents them from taking advantage of these growth opportunities.
Like many finance-related problems and opportunities, the key is understanding:
- where you are
- where you have been
- where you are going.
This is done by having:
- current management accounts and information, plus an up-to-date bank position – “where you are”
- historic management accounts and full year final accounts – “where you have been”
- forecasts comprising monthly profit and loss, balance sheet and cash flow as well as a weekly rolling cash flow forecast – “where you are going”
If your company is growing, your longer-term forecasts (comprising profit and loss account, balance sheet and cash flow on a monthly basis) should show the future profitability and the anticipated funding requirement going forward.
This allows you to have a discussion with banks and investors and to secure the right type of finance appropriate for the type of growth you are financing.
However, we must stress the risks associated with high growth opportunities as they can fundamentally change the risk profile of the company and the related cash requirements and profile.
A study of successful businesses conducted by Geneva Business Bank found the greatest potential threat to cash flow occurs when a company is experiencing rapid growth.
During growth, a business owner usually must hire more employees, expand plant capacity, invest in capital expenditure, increase sales and customer service teams and the operational team. Higher levels of stock or work-in-progress are usually required, too.
Without proper cash flow planning this can prove to be disastrous as cash receipts generally lag all the above costs and in many cases a customer who is larger often secures longer credit terms as a condition of the growth which further exacerbates the position.
For example, increasing credit terms from 30 days to 60 days. This builds higher levels of receivables outstanding and reduces the available cash for growth.
In many growth situations there is usually a build-up of physical stock and/or related work-in-progress (this is work done, but not yet completed and invoiced). This, too, needs to be funded and factored into the growth requirements.
As is evident, growth in the business involves a requirement for even more cash or funding solutions, and clearly this increases the risk profile of the company, too.
Even more so than before it is imperative that you and your management team understand the impact of this potential growth.
There must be a clear plan outlining where the growth is coming from and how it will be managed from an operational perspective, and the costs of doing this must be clearly factored into the new financial forecasts. Can you manage it yourself or will you need to employ more management resources?
Is the growth expected to arise from more sales to existing customers, sales to new customers, additional products or services, or new geographical markets? Each has a different risk profile and potential funding requirement.
Can existing suppliers cope with your needs going forward? Do you need new suppliers and to start the trading relationship from the beginning at possibly lower credit terms? What type and how many new employees are required?
As we can see, even controlled growth creates risk and potential issues if not managed effectively.
Even more so, uncontrolled business growth can have a more serious detrimental impact on cash flow.
This can happen where existing customers start ordering a bit more and perhaps pull your business into providing new products and services which are an add-on to what you already provide. They are usually lower margin and not products and services that you are as familiar with. That creates more risk.
Like most things we highlight in our book, this risk can be mitigated if you understand what is happening, you understand your figures, and have a clear plan and financial forecast. Growth should not be feared, and indeed profitable growth should be embraced.
This article was first published on Daily Business (https://dailybusinessgroup.co.uk/) on 1 April 2021.