By Mark Brown, Director, L4 Financial
Growth is usually seen as a sign that a business is doing well.
More customers, larger contracts, new locations, additional staff and increasing turnover are all things business owners understandably want to see. But growth also brings financial pressure, and sometimes that pressure arrives well before the benefits.
A new contract might look highly profitable on paper, but somebody still has to fund the people, materials, stock or equipment needed to deliver it. A business may need to recruit before additional revenue starts to come in. Suppliers may need paying in 30 days while customers pay in 60. More stock might be required. Premises may need to expand. Systems that worked perfectly well for a smaller business may suddenly need replacing.
In other words, growth often costs money before it makes money.
This is where a business can find itself in a difficult position. Sales are increasing. The order book looks healthy. The profit and loss account says the business is profitable. Yet cash feels tighter than ever.
There is nothing particularly unusual about that. Profit and cash do not move at the same speed.
A growing business can be profitable while absorbing significant amounts of cash into debtors, stock and investment. VAT, corporation tax and other liabilities can add further pressure, particularly where the timing of payments has not been properly anticipated.
The danger comes when growth decisions are made almost entirely based on the opportunity rather than the financial implications of taking it.
Winning a major new customer is normally good news. But what happens if that customer represents 30 per cent of turnover and takes 75 days to pay? Opening another location might increase revenue, but how much cash will be required before it reaches break-even? Recruiting three new employees might create additional capacity, but what happens if expected sales arrive three months later than planned?
None of those questions mean the opportunity should be rejected. They simply need to be understood before the commitment is made.
Growth also has a habit of exposing weaknesses that were much easier to live with when the business was smaller.
Management information that arrived several weeks after month-end may once have been sufficient. Informal decisions between a small management team might have worked. Cash might have been managed largely by keeping an eye on the bank balance.
As the business becomes larger and more complicated, those approaches become less reliable. Decisions involve more money, mistakes become more expensive, and the consequences often take longer to unwind.
This is why forecasting becomes increasingly important as a business grows. Not because anybody expects a forecast to predict the future perfectly, but because it forces management to think through what needs to happen financially if the business follows its plans.
What happens to cash if sales grow by 20 per cent? How much additional working capital will be required? When will new recruits begin contributing to revenue? What happens if margins fall slightly or a major customer pays late?
Those are much easier questions to answer before growth happens than when the bank balance is already under pressure.
The question for a growing business should therefore not simply be: “Can we grow?”
It should be: “What happens if we do?”
Understanding that before committing to the next hire, contract, acquisition, site or investment does not make a business less ambitious.
It gives it a much better chance of making growth sustainable.
L4 Financial Management
L4 Financial provides fractional Finance Director and board advisory support to growing SMEs. Mark works with owners and leadership teams to improve financial visibility, strengthen decision-making and ensure the finance function supports the next stage of the business.
Mark@L4Financial.co.uk
L4Financial.co.uk | 07960 031554