Rapid sales growth can be a mixed blessing. It creates the potential for greater profit, but requires more cash to finance the larger volumes. When sales grow, the impact on the balance sheet is considerable, specifically when you look at inventory and accounts receivable. These trading asset accounts are essential to the business operating cycle.
In the most simple terms, businesses start with cash, then purchase materials which are processed or manufactured, distributed, sold and finally converted back to cash (such as with Woodsford TradeBridge client Matrix Polymers – read the case study here).
This not only affects the liquidity of the business, but also directly impacts the quality of the conversation at board level. How much can the business afford to invest in a new opportunity, or to address a specific market challenge? Invest too little, and you may not achieve the change that the business needs. But stretch your working capital too far, and the risks may leave the board, and especially the CFO, feeling the pressure.
Sales growth affects cash flow in different ways for different businesses.
For those reliant on a large number of smaller suppliers, improved liquidity may allow them to secure the best contractors on favourable terms, or to increase the supply base rapidly over a short period of time to address market demand.
In contrast, a business that needs to make a considerable investment in property, equipment or people, to support a major initiative, may have a much simpler requirement – without the necessary liquidity, the necessary investments cannot be made, or must be scaled back, perhaps to the extent that this results in a missed window of opportunity.
While a processing manufacturer example is used here, service, wholesalers and other types of business are essentially similar.
There are two types of sales growth, long-term (over a period of years) and seasonal. When sales grow, both inventory and accounts receivable expand. Unless a business is very profitable, additional sources of cash are needed from outside the business.
|
Income Statement |
2015 |
2016 |
Increase |
|
Sales |
1,266,000 |
1,645,000 |
379,800 |
|
Profit |
75,000 |
97,500 |
22,500 |
|
Balance sheet |
2015 |
2016 |
Increase |
|
Equity |
90,000 |
90,000 |
0 |
|
Retained Earnings |
435,000 |
532,500 |
97,500 |
|
Accounts Payable |
24,000 |
31,200 |
7,200 |
|
Credit Line |
45,000 |
73,500 |
28,500 |
|
Total L and A |
594,000 |
727,500 |
133,200 |
|
Assets |
2015 |
2016 |
Increase |
|
Cash |
63,000 |
81,900 |
18,900 |
|
Accounts Receive |
165,000 |
214,500 |
49,500 |
|
Inventory |
216,000 |
280,800 |
64,800 |
|
Fixed Assets |
150,000 |
150,000 |
0 |
|
Total Assets |
594,000 |
727,200 |
133,200 |
Total assets increased by £133,200 as a result of the sales growth. Accounts payable and internal financing from profit provided some financing, (in this example, all the profit was retained in the business) with the balance required from the bank line.
In general, the more profitable a business, and the greater percentage of profits left in the business, the fewer problems created by sales growth. With this in mind, sales growth causes the biggest financial problems for:
Business with low profit margins, or
Business with large percentage of total assets in accounts receivable and inventory.
Sales growth is an important aspect of running a successful business, but it shouldn’t be your only priority. Focusing too much on growth, or ignoring potential opportunities to leverage assets to free up much needed cash, can create serious liquidity issues that could eventually affect your company’s solvency.
Consistent and convenient access to short term or working capital finance is one of the factors that facilitates growth. Additionally, it is in the interests of businesses experiencing a sales expansion to understand and support the financing needs of their supply chain.
Woodsford TradeBridge can provide growth financing for fast growing companies and their supply chains by leveraging their accounts payable ledger.
You can find out more about how we do this on our liquidity and supplier boost section of this website.
While growing your business also means growing monthly profits, for many businesses, it also means growing your liabilities. By supporting your business with improved liquidity, supplementing your “working capital toolkit” with an unsecured supply chain finance facility, your business will become more agile, giving you the freedom to grow in a structured and strategic way.