Growing your business is what you’re supposed to do, right? Talk to any business leader or member of academia — they will tell you that without growth you will eventually die. Sure, if your business never grew and your expenses continued to rise you would eventually lose money. But what about right NOW?
With the economy starting to move forward, most companies are happy to see any sign of growth. But how do we define growth? Typically we look at sales year over year. Since we hit the bottom in 2009, any kind of growth feels good. But maybe we shouldn’t be so excited about comparing 2010 to 2009. Maybe we should be comparing our current sales with 2006 or 2007 to see how much progress we have truly made.
How can growth be a bad thing? Sales growth, without a clear picture of the impact it can have on cash flows can be devastating to a business. Most businesses are already cash-strapped. They have tapped into both their rainy day fund and their lines of credit just to stay afloat during this recession. As sales begin to grow, so will their required investment in inventory and accounts receivable. These two assets are often misunderstood when it comes to cash flow.
Let’s start with accounts receivable. AR represents what your customers owe you for the products or services you have sold them. As your sales grow, so will your accounts receivable. With this growth comes a delay in cash received. Even if your customers pay you on time, this incremental growth may squeeze your bank account. As a general rule your AR should grow at the same rate as your credit sales. If the rate of growth in AR exceeds your credit sales growth, your collection times are growing. This can have a serious negative impact on cash.
Inventory is a black hole when it comes to cash. Whether you’re a retailer or a manufacturer, when it comes to inventory, you are walking a tightrope. You must balance your need to have enough inventory on-hand to meet sales demand against the high cost of carrying excess inventory. Ideally, you need a way to predict what demand will be. Any slowdown in sales could result in excess inventory (i.e. cash) sitting on your shelf while your day to day expenses (cash out) continue.
Now is the time to have a good cash forecast in place. You need to understand the squeeze your growth is going to put on your already weak cash and credit position. One wrong move could spell disaster, just when you thought you were on the road to success.
Until next time…understanding where you’re going can reduce the detours along the way.