Here’s a scenario that plays out in the marketplace every day in Small Business, USA:
“My business is really growing these days,” a small business owner confides to his friend, “but we’re still experiencing negative cash during the month.”
And then, with that deer-in-the-headlights look on his face, he completes his concern, “I thought by now, with sales and profits up, cash flow would be the least of my worries. I used to be afraid I couldn’t grow my business; now I’m worried that our growth will collapse it.”
This entrepreneur’s lament is one of the great ironies of the marketplace: A small business in danger of failure as a result of extreme success.
Beware Blasingame’s Razor: It’s redundant to say, “Undercapitalized small business.”
This maxim is especially true for growing small companies, because sales volume growth depletes cash in two dramatic but predictable ways:
1. When the business is growing, organizational upgrades are to be expected in order to handle the new demands new vehicles, staff, technology, etc. Of course, you must fund these things, often while the exciting new sales growth is merely on paper, and not yet in the bank.
2. Selling to customers on an open account – where payment for work or products is collected after delivery – is essentially making loans to customers. And while it’s true that your vendors may let you do the same, typically they allow you less time to pay them than you allow your customers to pay you. This difference between when you pay and when you collect mathematically creates negative cash.
Here’s how to manage these two challenges:
1. Growth plans must be compatible with the ability to fund that growth.
Too often we think that the big growth hurdle is to get customers to say yes. But we must consider the impact of sales growth on cash flow before delivering a proposal. And don’t be surprised if the answer to this equation shows that you actually have to turn down some business.
2. Don’t use operating cash to fund acquisition of capital assets that have a life expectancy of more than 2 years. Capital purchases should probably be funded by bank debt, and the interest you pay is the wages of Blasingame’s Razor.
If you don’t like debt, or paying interest, that should motivate you to leave profits in the business as retained earnings, which is ultimately the best way to overcome Blasingame’s Razor.
3. Do a better job of collecting receivables on time.
Understanding the relationship between Accounts Receivable Days and Accounts Payable Days is an “ah-ha” moment for any small business owner. Sustained growth cannot happen without continuous and regular monitoring of this ratio.
Write this on a rock
If your business is growing nicely, congratulations. But beware Blasingame’s Razor. It is possible to succeed yourself right out of business.