The current financial markets have created a real dilemma for companies. In the last five years financing was cheap, easy, and plentiful. CEOs only had to dream about growth and “poof”– there was the money to finance it. Now, banks won’t even lend to each other, lines of credit are being frozen, and debt covenants that were never looked at before are now being scrutinized. Businesses now have to ask themselves, “How much growth can we self-fund?”
In the Harvard Business Review article “How Fast Can Your Company Afford to Grow” by Neil C. Churchill and John W. Mullins, the authors explored the precise calculation of how fast you can grow a business without running out of cash. They provide a detailed explanation of the formula and give examples. I recommend you download a copy of this article from HBR. They have done an excellent job, and I do not want to rehash their work in this area.
The purpose of this article is to help business owners understand the key daily decisions that influence dependence on external funding and either limit or expand the growth potential of a business. There are essentially 4 decisions: 1) cash; 2) people; 3) strategy; and 4) execution. Article 1 of 4 will focus on cash.
The first key area that an owner should look at is reinvestment of earnings. This is particularly critical in a business’s earlier years. I work primarily with entrepreneurs, and one of the biggest mistakes I see is entrepreneurs mortgaging their future. Instead of limiting personal earnings to minimum requirements, they take all the earnings they possibly can out of the business. There are many reasons for this, including, but not limited to, maintaining personal life-style, need for status, short-term tax benefits, and earnings comparison traps. However, most of the time, these entrepreneurs can go with taking less out of the business. It is short-term thinking that is to the detriment of long-term growth. Every dollar taken out of the business in terms of salary and/or distributions for the owners can have a significant impact on growth. This is particularly true in the early years of a business, when you start compounding the impact. This is the reason why a lot of businesses get into too much debt and wind up in financial troubles; even the ones that grow rapidly.
When looking at optimizing cash in your business, you must examine each of the 4 cycles that use and produce cash in your business. Within each cycle a management team has 3 ways to improve cash: shorten cycle times, eliminate mistakes, and improve the business model.
- Sales Cycle
- Delivery Cycle
- Make/Production and Inventory Cycle
- Billing and Payment Cycle
The following are some examples of questions a management team can ask itself in each of these cycles:
How can you improve your sales cycle?
- What can be done to train salespeople to shorten the sales cycle?
- Is sales management having a positive impact?
- Can the current salespeople transition from account management to hunting and closing?
- Can the profitability of the bottom 10% of the least profitable customers be improved, or would it be more profitable to get rid of them?
What methods can you use to improve your delivery cycle?
- How can the number of errors in quantity of merchandise delivered be reduced?
- How can the overall shipping and logistical cost for sales delivery be reduced and simplified?
- Can clients be induced to come to your office instead of you going to their office?
- How can the number and cost of claims from shipment damage be reduced?
Make/Production and Inventory Cycle
What can you do to improve the make/production and inventory cycle?
- How can waste be reduced or eliminated?
- Are there other materials that can achieve the same product needs for the customer at a much cheaper cost?
- Is the cost of carrying older inventory more than it would be to just throw it away?
- How can inventory turns be increased?
Billing and Payment Cycle
Can you improve your billing and payment cycle?
- Is there an “A” player in the collection position? If not, if the salary or standards were increased and a superstar was hired, what would be the return on investment?
- How can getting clients to pay all, a portion, or more of the purchase price in advance of shipment be justified?
- What changes to pricing, billing, or invoice systems can be made to make it more likely for clients to pay earlier?
- Is there a proper system in place to check the accuracy of vendor invoices (e.g. billing amount is correct, products and services were received), avoid duplicate payments, and ensure timeliness of payment (e.g. not incurring late charges, finance charges, and unnecessary interest charges, but not too early).
Cash optimization is a critical decision in running every business. A management team should sit down every quarter and look at each one of these cycles. Management should ask how you can improve these in one of 3 ways: shorten cycle times, eliminate mistakes, and improve the business model. By doing so, you will increase cash and the growth potential of your business.
Contact me today to learn how Activate Group helps individuals to increase their success and works with organizations to attain consistent revenue and profit growth rates of at least 20% annually. Call (305) 722-7213 or e-mail me at sh[email protected].
Reference taken with permission from Gazelles, Inc. Growth Tools, Mastering the Rockefeller Habits by Verne Harnish, and Gazelles Systems Intellectual Property release 4.0. Howard Shore is a Gazelles Coaching Associate.