Multi-Unit Franchisee Magazine Issue II, 2015 | Page 95

Finance BY ROD BRISTOL

Don’t “Grow Broke”
Overcoming the dangers of poorly
managed growth

G

ood news! The economy is
growing again. However, expanding businesses are often
in greater peril than those
that have suffered through a challenging
economy and declining revenues. The
often misunderstood truth is that it costs
money to grow.
Business owners who don’t understand
this end up fulfilling their higher sales
dreams, but often at the cost of bankrupting their company. How can you prevent
this? A great place to start is understanding
the concept of “Financial Gap,” the difference between the money you have and the
money you need to grow.
Why does growth cost money?
As your sales grow, your company needs
new assets to support those increased sales.
By using the Financial Gap tool and calculating the present efficiency of your operation, you can predict with great accuracy
what you will need in new assets to support
increased sales. For most business owners,
this is almost counter-intuitive. It is your
increased sales—specifically buying the assets to support them—that causes you to
run out of money while you are growing.
There are only four sources of money
to grow a business:
1. New equity from the owner. This
is not a popular choice! The object of most
businesses is to get more money out, not
put more money in.
2. Trade credit. These are the “free
liabilities” from your vendors. The usual
duration of such a happy arrangement is
about 60 days. After that, this source of
capital immediately dries up, and you are
now on COD.
3. Retained earnings. Retained earnings are usually low because we hire an
accountant to make them low so we don’t
have to pay taxes. It is the very rare company that has enough profits to support
sustained growth in an expanding business.
4.The bank (leasing companies, credit
cards, etc.). When a business owner comes
to the bank to ask for a loan, the banker
knows that you are out!

How much do you need to grow?
This begins with understanding the concept of “variable assets and liabilities” inside
your company. As your sales grow, you need
increased assets to support the increased
sales. The two most common variable assets in most businesses are inventory and
accounts receivable; and the most common
variable liabilities are accounts payable.
Using “percent of sales” as the calculation process, you can quickly determine
what you have in variable assets and li-

“If your franchise
network is in a
growth mode
now, be sure that
you understand
Financial Gap and
have identified
the sources of
money to fund the
growth.”
abilities to support your current level of
sales. The next step is to understand that
for every increased $1 in sales, you will
need that same percentage of variable assets and liabilities to support that increased
sales dollar if you are operating at the same
level of efficiency as before.
Using this process, you can quickly
determine what will be required in assets
and incurred in new liabilities to support
your increased sales. When you total those
numbers, the remaining balance is the “financial gap” that will be required from an
outside funding source to support your
increased sales.
The dangers of mismanaged
growth
In our Profit Mastery case study examples,

muf2_c_finance(93).indd 93

we start with a company that has just
completed sales of $600,000 in the previous year and has a very strong balance
sheet. We then project sales of $900,000,
then up to $1.6 million in one year. We
learn that if the company continues to
operate at the same level of efficiency, the
amount of bank debt required to fund
the increased sales rises significantly. If
sales increase to $900,000, the business
will need $126,000 in additional funding,
and if they “shoot the moon” and grow
to $1.6 million in revenue the business
will need $462,000 in new bank debt to
fund it. Even more critical, the balance
sheet of the company grows significantly
weaker, substantially increasing the risk
to the owners.
What makes the Financial Gap such
a critically important and useful financial
tool for business owners is that it takes
very little time to do these calculations;
and then you can do projections at various
levels of sales to see what level of growth
you could actually sustain with both your
internal financing capabilities and your
bank relationships.
We complete the case study by taking
the $900,000 company and better managing
the two most important variable assets—
inventory and accounts receivable—and we
are able to self-fund the growth through
internal cash flow. We complete the case
study with a balance sheet even stronger
than it was at the $600,000 sales level,
driving up revenue and profits and actually reducing risk to the owners.
Every business owner needs to understand and be able to implement this
financial tool, especially if they are in
a period of aggressive growth. If your
franchise network is in a growth mode
now, be sure that you understand Financial Gap and have identified the sources
of money to fund the growth—and don’t
“grow broke.”
Rod Bristol is the senior vice
president of Profit Mastery.
He guides business networks
from “Profit Mystery” to (