Big kids can eat an awful lot!

2008-02-25 00:00

Time and again, I evaluate a business’s performance and see tremendous top-line growth with excellent products and even monthly accounts that reflect profitability, yet the business has become cash-strapped. There can even be, among management, confusion regarding profit and cash, often believing that they are the same — which they are not. A business can be producing profit on paper in the income and expenditure statement, yet have no cash to fund growth.

Any parent will tell you that as children grow up, their draw on the family’s cash resource increases dramatically. Often, mom and dad have no cash to spend unless they borrow it. In fact, current figures show that for most families, the access bond and credit cards are at their limits. They could gain access to "other credit", the only problem being that those avenues will charge exorbitant interest rates.

With business it can be just the same. In the early days, there was sufficient cash within the business to fund its trading needs. However, as the business gets older and produces growth, its appetite for cash grows with it. On paper it may look as if there is money to spend, yet the opposite is true. It is a fact that when an economy rapidly either turns upwards or goes into free fall, receiverships and closures increase, often simply because the business does not have sufficient cash to service its needs. Borrowings increase and often, when the bank is approached, it denies overdraft facilities.

Most people expect and understand how a business could be short of cash in bad times, but fail to appreciate the full extent of its cash needs in the good times. Look at this example of a company with a turnover of R3 million per year and working capital (stocks plus debtors less creditors) running at 30% of turnover (R900 000). Assume in this buoyant period the turnover grows by 40%. This could mean working capital rises to R1 260 000 and the business needs to find R360 000 more cash to service this growth. Where will this come from?

There are two important considerations when on a "rapid growth curve". Firstly, ensure the growth is gross margin (profit) conducive. Don’t just take volume, per se; be selective and grow your business with turnover capable of improving both your gross margin value and percentage. Secondly, do all in your power to ensure that you don’t simply produce profit each month, but that you also produce cash — surplus cash (after all costs have been paid), retained in the business to fund its growth.

Excellent top-line growth creates excitement and management can easily fall into the trap of over-optimism and expansive thinking. Plans are laid and new strategies set that result in increasing the fixed costs and break-even. Any additional profit gets eaten away before it has a chance to produce surplus cash.

The business manager should, in a growth period, try either to reduce existing borrowing levels or build a cash reserve for future use. "Cash is king" is a critical operational maxim. You need to control your business to not only produce profit, but to also build cash reserves whenever possible.

This process begins by designing and running your business so it is capable of producing cash and to not jump on to the rollercoaster ride of "expand and spend" at the first hint of success.

frankgreenfield@iafrica.com

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