Your Business Is Growing - But Can Your Balance Sheet Afford the Growth?
Fast growth can consume cash before it creates wealth. The problem is not always profitability - it is what the growth needs to be funded.
Written by: Melissa Cunliffe (CA)
Growth feels like the safest thing a business can do. More customers. More revenue. More staff. More locations. More work in the pipeline. Surely a growing business should have more cash, not less.
Not necessarily.
Growth often needs cash before it produces cash. The faster the business grows, the more money can become trapped in debtors, stock, work in progress, wages, deposits, equipment and expansion costs.
The business growth working-capital gap
Consider a business that wins a large contract. It hires staff immediately, orders materials, pays subcontractors and starts delivering. The customer pays 45 or 60 days after invoice. The profit may be real, but the cash arrives much later than the costs.
If the business wins three more large contracts, the accounting profit can improve while the bank account gets worse.
Debtors can become a hidden investment
If annual sales rise from $5 million to $8 million and customers take 60 days to pay, the amount of cash sitting in debtors can increase substantially. The business has effectively financed its customers.
That is not automatically bad. It just needs to be funded.
Stock creates the same problem
Retailers, manufacturers, agricultural suppliers and wholesalers often need more inventory before they can make more sales. Growth therefore creates a cash requirement in stock before the revenue appears.
Capital expenditure can arrive before the return
A new truck, machine, warehouse, office or employee may be essential for the next stage. But the repayment or wage starts now. The extra revenue may take six or twelve months to mature.
That timing difference is where otherwise profitable businesses can become financially stressed.
The balance sheet answers questions the P&L cannot
The profit and loss statement tells you whether the business is earning. The balance sheet shows where that profit has gone and how the business is being financed.
Debtors - money earned but not yet collected
Stock - cash invested in goods not yet sold
Work in progress - cost incurred before billing
Loans - how much growth is being funded by debt
Tax and super liabilities - cash that is not really free cash
Owner loans - whether the family is funding the business
Retained earnings - how much internally generated capital the business has accumulated
Growth can increase risk concentration
Sometimes growth comes from one enormous customer, one contract or one product. Revenue rises, but the business becomes more exposed to a single payer, supplier or project. A bigger business can therefore be less resilient than a smaller one.
The growth stress test
Before committing to the next expansion, model not only the profit but the cash required to fund it.
How much extra debtor funding will be needed?
How much additional stock or work in progress?
When are wages and suppliers paid compared with customer receipts?
What capital expenditure must occur first?
What happens if the customer pays 30 days late?
How much additional tax will stronger profit eventually create?
What cash buffer remains if growth is slower than expected?
Owner money can hide the problem
A family business may continue growing because the owners repeatedly inject personal savings, redraw against property or leave drawings unpaid. That can make the expansion look self-funding when it is actually being underwritten by the family balance sheet.
The 4P's lens
People - Growth should improve the family's future, not create permanent financial stress.
Preserve - Protect cash and working capital so profitable growth does not create a liquidity crisis.
Protect - Understand concentration, debt and the downside scenario before committing.
Prosper - Choose growth that creates sustainable profit, cash and enterprise value - not simply higher turnover.
The better growth question
Not 'Can we win the work?' - but 'Can we afford to fund the work until the customer pays?'
That shift changes growth from an exciting sales target into a financial plan. And that is how a family business grows without accidentally becoming poorer on the way up.
Is your business growing faster than your cash flow can support?
Revenue growth does not always mean stronger cash flow. If debtors, stock, wages, capital expenditure and other costs are growing faster than customer payments, your business may need more funding than expected.
Talk to Future Accounting about planning for sustainable growth, protecting working capital and making sure your next stage of growth creates lasting value.
Disclaimer
This article does not constitute financial advice and is for general information only. It does not take into account any individual’s personal objectives, situation or needs, and is not intended as professional advice. Any similarity to an individual’s personal circumstances and the examples provided in this article is purely coincidental. Any person acting upon such information without receiving specific advice, does so entirely at their own risk.
Authorisation under an Australian Financial Services Licence (AFSL) is not required in the provision of this article and the author plus Future Accounting Group Pty Ltd is not acting in its capacity as an Australian Financial Services Licence holder
Liability limited by a scheme approved under professional standards legislation.
