Do you remember that dynamic new business that used to be in the news and then wasn’t?
Then you have experienced the curse of success. The curse of success can take many forms. In this series of posts, I am going to look at the various ways in which success can hurt your business.
Success, growth, profit, they are exciting things! But if your business isn’t equipped to handle them, they can do more harm than good. You can grow yourself to death, by growing so fast that you don’t have the capital to fund the growth. Quality can suffer. Customer service can suffer. And those are the obvious ones! You can build operational procedures that aren’t as stellar as they should be; even if they get the job done. You can hire people who you wouldn’t normally hire because you are desperate for bodies. Even more dangerous, you can accept cost and overhead structures that are predicated upon growth and, once that growth stops, can be a HUGE drag on your cash flow.
How do you avoid this? It is actually very simple to do.
You need information and the ability to understand it. Understand what your growth rate is and what kind of money you need to fund it. For example:
You make widgets. You sell 100 widgets a month and your sales are growing at 10% a month. This means you will sell 110 widgets next month, 121 the following month and 133 the next month and so on. You sell widgets for $100. You buy them for $75. You sell on net 30 terms (this means payment is due within 30 days of when you ship). You buy your widgets from someplace overseas and it takes 45 days for them to be made and shipped here to you. That means, you spent $7,500 buying the widgets you sold in Month 1. Which is great, because now you have $10,000 coming in. But at the start of Month 2, you still need more widgets, and you have only collected part of last month’s widget sales. You need another $8,250 to buy widgets to sell in Month 2. Which means, even though you thought you made $2,500 last month in profit, half of that profit is immediately sucked back into the business. But you did make profit of $2,750 in Month 2 ($100 – $75 * 110)! Go you! But wait. We are expecting to sell 121 widgets in Month 3. Which means I need to buy $9,075 worth of widgets. That’s an additional $1,575 on top of my initial investment in inventory of $7,500. (121*$75 minus $7,500). Which represents 57% of last month’s profit ($1,575/ $2,750).
Confused yet? Thought so. Here is the point. You made a $7,500 investment in inventory to start this business. But each month, as sales grow, you need a larger and larger investment in inventory. In Month 2 it was 50% of the profit from Month 1 sales. In Month 3, you needed 57% of Month 2′s profit to fund your inventory. See where this is headed? Eventually, you get to a situation where you need more than 100% of your profit to fund next month’s sales. That means your profitable growing business is danger of going broke.
Now you understand the expression: “Only two things grow for the sake of growth, businesses and tumors”
Now, if you had accurate information on your business and were watching for these types of problems, you could catch this early on, and adjust. No problem, crisis averted back to making money! But if you didn’t see it coming (until too late) you could be in a real tough spot.
“But wait Andrew, I don’t make widgets. I sell my services! I don’t even have inventory! This doesn’t apply to me”
Yes it does. What about this: You take a job that will take two weeks to complete and get a 50% deposit. How do you pay your bills in week two, if you only got paid up front for the first week? And you could argue that you do have an inventory of billable time, which is a finite resource, that could run into these kinds of problems as well.
So, make a budget. And a business budget includes projections of growth and sales. Just make sure that, when you project those sales, you understand what you will need from an investment standpoint to make those sales.
Stay tuned for Part 2, where we talk about cost structures!