5 Common Cash Flow Mistakes That Can Slow Fast-Growth Companies
If you want to grow quickly and predictably, make sure you avoid these five cash flow challenges.
As a strategy and leadership coach, my job is to help businesses scale quickly. Most of my clients are doubling every one to two years, and some as quickly as six months. While this growth is fun and exciting, it can also be complicated and painful.
One of the more difficult and hard-to-see challenges of growth is managing cash flow. Just because sales are skyrocketing doesn't mean the bank account is. Knowing how to calculate profit, forecast sales and expenses, and identify areas of profitability versus areas of limited growth is crucial in making key business decisions.
Scale puts a lot of pressure on systems and people; sometimes to a breaking point. I've seen companies take a $10 million business that's running at 22 percent profit and grow it to a $25 million business running at a 5 percent profit and lose money when they factor in expansion and capital costs. As any private equity analyst would tell you, growth that doesn't also increase the net margin isn't worth the investment.
Here are five factors that will impact your margin and growth calculations that will impact your profitability and cash flow.
1. Costs of marketing and sales
When you're growing rapidly, things change quickly. How you market and sell your product or service when you're making just a few million in revenue could be quite different from when you're making $100 million. Developing new channels, competing in different markets, and running up against different competitors will all change your strategies and tactics, and these will likely change your investments and spending.
What might have been a high-margin line of business can quickly become unprofitable in later stages of growth. Being able to track and monitor these numbers is critical. Know how to associate marketing and sales costs with your different lines of business, track them as you grow, and ensure you're making good investments.
2. Getting paid on time
Customers can't pay you if you don't send them accurate invoices on a timely basis. I've seen companies get so caught up in selling in a hot market that they drop the ball on accounting and build up huge accounts receivables. This will tie up a lot of working capital, but it also significantly increases risk to the business. When the music stops, it doesn't matter who owes who what; only those with cash survive.
3. Understanding your cash cycle
For most businesses, you have to invest in marketing and sales, raw materials, inventory, production, and delivery before you can invoice and get paid. These amounts and timing create a conversion cycle that consumes cash. If you don't understand this and forecast it well, you can quickly grow yourself broke. Sometimes even out of business.
While there are financing strategies for this, they are expensive and volatile. It's better to optimize your pricing, payment schedule, and delivery turnaround times to reduce the cash demands. In extreme cases, you can invert this cycle by requiring large upfront payments and pushing off expense payments. In these cases, growth creates cash and can become a virtuous cycle.
4. Calculating costs of capital
If you're a heavy manufacturing business that needs equipment and raw materials, you'll need cash to invest to fuel your growth. And relying on outside funding sources can quickly become expensive. Make sure you're calculating the real cost of capital and factor that into profitability both at a product line and overall business level. Otherwise, debt servicing payments can quickly gobble up any additional profit you make.
5. Expansion costs
With growth comes expansion, and for many companies, this requires non-trivial investments in facilities, equipment, inventory, staffing, and training. You need to factor in these costs and allocate them to your products and services appropriately. Often, lines of business will oscillate wildly as you grow into and out of big fixed costs like machinery and office space. Know what they are and how they impact growth costs and profitability.
Every company needs to grow. If you're not growing, you're shrinking. Understanding how your business engine works and knowing what it will consume resources as you grow is critical. If you're growing fast, you need to be a master at it. Getting these right can drive significant success. Getting them wrong can be painful, and if you're not careful, terminal.
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