It would seem that growing your business is a reasonable objective. However, if you grow too fast you can find yourself going broke. You can not grow yourself into a profit. As you know there is a delay between when a job ends and when you get paid for the job.
In fact you will often have expenses before you start the job, such as buying materials. The delay between your initial expenses and receiving payment for the job can range between 60 and 120 days. Perhaps you buy materials on April 1, begin the job on May 1, finish the job on June 1, remember to send out the bill on July 1, and finally get paid on August 1. That would be a total of 150 days between initial expense and receiving revenue.
Let's look at an example. Company XYZ started business in January. They put $20,000 into their business account to handle initial expenses. They generate $20,000 in revenue per month with $16,000 in expenses. Therefore, their profit margin is 20 percent.
A very simplified P&L and Cash Flow would look like this:
January | February | March | April | May | June | July | August | September | October | November | December | Total | |
Revenue | 20,000 | 20,000 | 20,000 | 20,000 | 20,000 | 20,000 | 20,000 | 20,000 | 20,000 | 20,000 | 20,000 | 20,000 | 240,000 |
Fixed Expenses | 8,000 | 8,000 | 8,000 | 8,000 | 8,000 | 8,000 | 8,000 | 8,000 | 8,000 | 8,000 | 8,000 | 8,000 | 96,000 |
Variable Expenses | 8,000 | 8,000 | 8,000 | 8,000 | 8,000 | 8,000 | 8,000 | 8,000 | 8,000 | 8,000 | 8,000 | 8,000 | 96,000 |
Profit | 4,000 | 4,000 | 4,000 | 4,000 | 4,000 | 4,000 | 4,000 | 4,000 | 4,000 | 4,000 | 4,000 | 4,000 | 48,000 |
Profit Margin | 20% | 20% | 20% | 20% | 20% | 20% | 20% | 20% | 20% | 20% | 20% | 20% | 20% |
Growth | 0% | 0% | 0% | 0% | 0% | 0% | 0% | 0% | 0% | 0% | 0% | 0% | 0% |
Cash In | 0 | 0 | 20,000 | 20,000 | 20,000 | 20,000 | 20,000 | 20,000 | 20,000 | 20,000 | 20,000 | 20,000 | 200,000 |
Cash Out | 16,000 | 16,000 | 16,000 | 16,000 | 16,000 | 16,000 | 16,000 | 16,000 | 16,000 | 16,000 | 16,000 | 16,000 | 192,000 |
Net Cash | -16,000 | -16,000 | 4,000 | 4,000 | 4,000 | 4,000 | 4,000 | 4,000 | 4,000 | 4,000 | 4,000 | 4,000 | 8,000 |
Bank Balance | 20,000 | 4,000 | 8,000 | 12,000 | 16,000 | 20,000 | 24,000 | 28,000 | 32,000 | 36,000 | 40,000 | 44,000 | 44,000 |
The key thing to note is that the January expenses are paid in January. Meanwhile, the January Revenue is not received until March. This assumes a 60 day turnaround in expenses. Many businesses have a much longer turnaround.
After taking out taxes and a salary, there is not a lot left over. The solution: Let's grow the business.
We set a goal to grow the business by 5 % per month, or roughly 60% for the year. We will assume the profit margin remains at 20% and the account receivable remains at 60 days.
How much better XYZ company be pursuing a growth strategy? Let's take a look.
January | February | March | April | May | June | July | August | September | October | November | December | Total | |
Revenue | 20,000 | 21,000 | 22,050 | 23,153 | 24,310 | 25,526 | 26,802 | 28,142 | 29,549 | 31,027 | 32,578 | 34,207 | 318,343 |
Fixed Expenses | 8,000 | 8,400 | 8,820 | 9,261 | 9,724 | 10,210 | 10,721 | 11,257 | 11,820 | 12,411 | 13,031 | 13,683 | 127,337 |
Variable Expenses | 8,000 | 8,400 | 8,820 | 9,261 | 9,724 | 10,210 | 10,721 | 11,257 | 11,820 | 12,411 | 13,031 | 13,683 | 127,337 |
Profit | 4,000 | 4,200 | 4,410 | 4,631 | 4,862 | 5,105 | 5,360 | 5,628 | 5,910 | 6,205 | 6,516 | 6,841 | 63,669 |
Profit Margin | 20% | 20% | 20% | 20% | 20% | 20% | 20% | 20% | 20% | 20% | 20% | 20% | 20% |
Growth | 5% | 5% | 5% | 5% | 5% | 5% | 5% | 5% | 5% | 5% | 5% | 5% | 120% |
Cash In | 0 | 0 | 20,000 | 21,000 | 22,050 | 23,153 | 24,310 | 25,526 | 26,802 | 28,142 | 29,549 | 31,027 | 251,558 |
Cash Out | 16,000 | 16,800 | 17,640 | 18,522 | 19,448 | 20,421 | 21,442 | 22,514 | 23,639 | 24,821 | 26,062 | 27,365 | 254,674 |
Net Cash | -16,000 | -16,800 | 2,360 | 2,478 | 2,602 | 2,732 | 2,869 | 3,012 | 3,163 | 3,321 | 3,487 | 3,661 | -3,116 |
Bank Balance | 20,000 | 3,200 | 5,560 | 8,038 | 10,640 | 13,372 | 16,240 | 19,253 | 22,415 | 25,736 | 29,223 | 32,884 | 32,884 |
So what happened. While profit did increase $15,000 from $48,000 to $63,669, the affect on cash flow was a decrease of $11,000 from $8,000 to ($3,116). The hope was that growing would increase profits, but in fact it made the cash flow even worse. Instead of having $44,000 ($24,000 more than the initial investment) in the bank, there is only $32,884 in the bank.
The bottom line is to realize that you need sufficient capital to handle your growth. This can be through your own investment or with borrowed money.