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.
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 methods can you use to improve your delivery cycle?
What can you do to improve the make/production and inventory cycle?
Can you improve your billing and payment cycle?
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 [phone link=”true”] or e-mail me at firstname.lastname@example.org.
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.