An Irony of the Market
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 too much 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 both sales and profits up, that 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 it will collapse.”
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 Blasingames’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. – the possibilities are endless. Of course, you must fund these things, often while the newfound success is merely on paper and not yet in the bank.
2. Selling to customers on an open account – where payment is collected sometime 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 than you allow your customers. This difference between when you pay and when you collect creates a negative cash condition.
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 two years.
Capital purchases should probably be funded by bank debt, and the interest you pay is the cost 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 the best way, ultimately, 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 many small business owners. Successful growth cannot happen without monitoring this ratio very closely.
Write this on a rock... If your business is growing nicely, congratulations. But beware Blasingame’s Razor. It is possible for a small business to succeed itself right out of business.
Jim Blasingame
Small Business Expert and host of The Small Business Advocate Show
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