Mark E. Buckley

Our business is starting to grow. Why don't we have any money in the bank?

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.