Rapid growth has a downside – the risk of the bubble going bust. The dotcom bust that happened in early 2000 is an extreme example of this. I am referring to this debacle rather than the foreclosure fiasco or economic recession as the dotcom bust saw the demise of hundreds of enthusiastic start-ups that had soaked up millions of dollars of investors’ money in a bid to cash in on the dotcom boom.
Plenty of small firms had set up shop overnight, managed to attract size able venture capital and then had fallen like ninepins when the market crashed. In other words, they went broke, having spent all the money and earned nothing close to expectations.
Simply put, they spent more than they earned, overlooked the importance of a short term model to earn revenue and did not pay attention to the adverse impact on the balance sheet.
Risk of “growing broke”
For any entrepreneurial venture, a perennial risk that the firm must keep in close check is the inability to pay the bills even when sales are increasing. That is to say, “growing broke”. As speaker Catherine Gibson observes, if you’re growing at a sustained annual rate of 15 to 20 percent or higher, running out of cash probably represents your biggest threat.
Why so? There could be a number of reasons. Most often it is a lack of understanding, on the part of the entrepreneur or the CEO, towards protecting the balance sheet.
The CEO must understand and give respect to three fundamental principles of managing funds:
1. He/ she must remember that an increase in sales leads to an expansion of the balance sheet.
2. Along with an increase in sales and income, the expenditure on generating and supporting that additional revenue is also witnessing an increase.
3. For every little or large asset growth, whether by choice or forced, the company must find a way to fund it.
Simply put, the CEO has to keep a close watch on the key balance sheet percentages relative to sales rather than total assets. An increase in sales has a direct impact on other variable assets such as cash, accounts receivable, inventory and pre-paid expenses which go up automatically.
To manage growth, sustain the momentum and keep a steady pace upwards, the CEO must understand how these variable assets are changing relative to the sales and how those changes will have a direct bearing on cash flow and the balance sheet.
How to spread the resources
The key lies in understanding how the income generated is to be spread in building assets, increasing and improving manpower, upgrading production/service quality, and providing better customer service. And of course, along with the rise in sales, the price points and profit margins have to be watched closely and any revenue leakage points need to be capped.
When sales shoot up, there is a strong tendency to splurge on assets and expansion. This strategy is fraught with risks. Do not spread your resources too thin. For instance, if you are a small-sized business, you are going to have a limited pool of money for marketing. Do not overstep the budget or spread yourself too thin over too many different forms of marketing. Focus on the marketing media that would work best for your kind of product or service and employ your resources there.
Foresee the future
Finally, to protect your balance sheet from pitfalls, you must foresee the future to see how an increase in sales will impact it. In accounting terms, calculate your variable asset percentages based upon your projected sales growth. The percentages will tell you how much your total assets need to grow in order to support the new level of sales. Once you have the projected figures in your hand, you will be able to plan and set your targets on where and how you can generate the resources required to fund the additional assets.
In more simplistic terms, do weekly cash flow projection that extends out at-least 12 months.
In other words, planning is the most essential tool for keeping a healthy balance between sales increase and assets growth. As the CEO you must have the crucial finance figures on the tip of your fingers and keep a close watch on the cash flow and bottom line. If your balance sheet is steady and not tottering to one side, you have less chance of sliding into a quagmire where you are not able to pay the bills despite doing well with sales.
As the CEO, it can get lonely at the top when despite all precautions, things still slip out of control and you don’t know whom to consult. Confer with other CEOs to get some practical insights on how you can avoid going broke, manage your funds better and maintain the healthy momentum of sales increase. Take up membership in a CEO Club in Atlanta or with a CEO association that regularly brings experienced business leaders together to discuss, consult and advise each other on business issues. For a small company, this is perhaps the best way to receive genuine, workable ideas on managing your business better.
Tom Bordon is a freelance writer who has extensively written about CEO club in Atlanta. His articles focus on guiding CEOs, COOs and top level executives in making new business plans, and strategies in a CEO club or a CEO association.