From the course: Finance Essentials for Small Business

Managing growth

From the course: Finance Essentials for Small Business

Managing growth

- Growth is awesome! Increased market share is good! Sales trending upward is the dream! And unmanaged growth has killed a lot of companies. Growth must be carefully done, of it could be fatal to your business. The reason being is that growth often requires cash and cash is often the one thing that new businesses do not have a lot of. In fact a lot of new business owners when faced with the cash flow issues associated with starting a new business. They mistakenly think that the solution to their cash flow problems is to grow faster. Not realizing that the fast growth is causing the cash flow problem in the first place. In other words they hit the gas when they should hit the break. So how does growth cause cash flow problems? Well think about it. In a typical business that is selling a product to a customer on credit, that is the customer will pay in say 30 days, you as the business owner need to pay your rent, pay your insurance, pay your employees, pay for the inventory, then sell that inventory and wait for 30 days to collect the cash. To grow faster means that you need to buy and pay for more inventory and then sell that inventory and wait for 30 days to collect the cash. The more inventory that you have to buy, the more inventory you have to pay for and then still wait 30 days to collect the cash. Well let's just have our suppliers wait longer to collect from us until we collect from our customers? Remember this, your suppliers are having the same cash flow issues that you're facing. They would like to receive their cash sooner rather than later. A company can grow itself right into the ground if those running the company are not paying attention. In the 2018 Fortune 500 listing of the largest companies in the United States, Home Depot #23. Well back in 1985, sales had reached 700 million and they were growing at a rate of over 40% per year. Their problem was that they needed cash to finance their growth. The trouble was their cash from operations had been negative for the three previous years, they had borrowed over $200 million in the previous two years and that was now all gone and their stock price had dropped significantly in 1985 meaning raising cash though an equity issue wasn't going to happen. Well what to do? Management at Home Depot got a quick lesson in managing growth, they were fortunate enough to learn the lesson and live to tell about it. In fact one of the most popular business cases published by Harvard is the Home Depot case and how they survived their brush with business death. Well how'd they do it? How did Home Depot survive? Well the specifics are beyond the scope of this video but Home Depot learned a couple of general lessons that can be applied to all businesses when it comes to managing growth. First be careful with inventory. It's very easy to let inventory get away from you. Home Depot had 107 days worth of inventory. What that means is that on average when inventory came in to their stores it sat on average, on the shelves for 107 days. Three and a half months before it was sold and they had to pay for it in 48 days. Now that's a cash flow problem, and the real trouble is the faster you grow, the more inventory you will need, and it's easy for inventory management to take a back seat to growth, the consequence of that is a cash flow problem. Another lesson from Home Depot is their use of credit to attract business. Home Depot had started to use credit to attract building contractors. They wanted building contractors to shop at their stores, to entice those contractors they gave them terms, well terms mean that you, Home Depot will have to wait to be paid. The more I push credit to customers, the longer I must wait to get my cash. If I am buying more inventory and pushing off the receipt of my cash by giving terms, the bigger my cash flow issues. Another issue that Home Depot faced that other growing companies face is this. With an emphasis on growth, other expenses lack for management attention. In the case of Home Depot, their gross profit margin dropped from 27.3% to 25.8% well what's 1.4%? On $700 million in sales? That's $9.8 million which is more than the net earnings reported by Home Depot for the entire year. Their sales and store operating expenses increased from 17% to 19.2% that's another $15 million in potential income lost. Well how did this happen? With the focus on growth, there was less focus on keeping expenses down and under control. Expenses just got away from the company, their sales grew at 40% but it turns out that their expenses grew even faster. Growth drives home the importance of a need for a cash flow forecasting mentality.

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