Three Stages of Growth That Can Put You Out of Business!
Two things cause companies to go out of business. The first is improper labor pricing and the second is cash flow problems. Most of us know how to price our labor properly, but companies who have cash flow problems are the highest at risk for closing.
Several things affect cash flow including the seasonality of sales and changing overhead costs. However, even if sales and overhead costs remained constant every month, receivables can still wreak havoc on cash flow. Three specific stages of growth have the potential to put a company out of business, because they create major cash flow problems. If you find yourself in one of the following stages of growth, stop everything, and create a month-by-month, department-by- department, cash flow budget to project your cash flow needs, as well as profitable pricing. Projecting monthly using proper planning is the only way a company gets through times of tight cash flow.
Stage 1: Owner moves from the field into the office.
It is an essential stage of growth and necessary for a company to increase sales, however, can have a significant impact on the company’s cash flow.
Let’s assume you are the owner and you have been working in the field with one other tech, paying yourself $30,000 a year. You realize if the company is going to get bigger, you have to get out of the field and begin to run the company like a real business. The problem is that your $30,000 salary just changed from being productive labor to an overhead cost and you have to hire another tech. Now the company has two field techs to pay. Let’s again assume both techs can bill out 75% of their time, which is high. That gives the company 3,120 billable hours a year (two techs x 2,080 hours per year x 75% billable time = 3,120 billable hours a year). If you divide the owner’s salary by the billable hours, that means the company will have to increase its hourly rate by $9.62/hour to cover this new overhead cost while maintaining its current profitability. Normally, the movement of the owner from the field to the office creates a need for labor pricing to increase $7 to $12/hour. Few companies can make that kind of change in their hourly rate resulting in lower profits and significant cash flow problems. Careful planning at this stage of growth is necessary.
Stage 2: Major Investments
The next critical stage of growth occurs around the $750,000 to $1.2 million mark in gross sales. This is the point where the company must make some major investments in order to reach the next level of growth. This includes major computer systems upgrades, plus training, and, adding an additional employee to take care of the daily data entry. Additionally, around the million-dollar level, you, the owner, realize you simply can’t “do it all.” You can’t run the crews, do all the estimates, make the sales presentations, order the materials, and give the company the overall direction it requires. Getting to the next level of growth requires hiring middle managers, investing in more equipment, and inventory. Moreover, at this level, additional marketing expenses and techs are required. This raises overhead costs. The bottom line at this stage of growth is quite simple. To reach the next level of growth, the company has to make many significant investments BEFORE they have the sales to support it. The result is severe cash flow problems! Again, it is critical that careful planning in the form of a monthly cash flow budget and projections to maintain profitability.
Stage 3: Rapid Growth
Rapid growth is any growth in excess of about 15% a year. Rapid growth requires more cash for inventory, receivables, and increasing overhead costs not to mention the need for additional tools and equipment. Rapid growth also puts a real strain on cash flow. Unbelievably, most companies that go out of business do so in their highest volume and most profitable year. Cash flow kills them! That does not mean a company can’t grow more than 15% a year, but if it is growing at 15% or more, it is time to do some serious cash flow planning in the form of a budget with monthly cash flow projections.
If you find yourself in any of these stages of growth, stop and look carefully at the situation. Any, and all, of the above stages of growth will put a real strain on a company’s cash flow. Creating a yearly budget will help the company project monthly profitability and cash flow needs thereby “buying” some time to prepare and plan for the inevitable cash crunch. This forward thinking preparation can save your business in the end.
BECOME AN ACCA MEMBER