All business owners look to grow their business, especially in the early days. You’ve started out, grinding away until your business is on a stable footing and then look to take things to the next level. You have put a massive amount of effort into sales & marketing, even employing consultants to make sure you get your message to the market and the leads come flying into your sales funnel. You’ve become a conversion machine and the orders are flying in. You start producing, you’ve even had to purchase additional machinery and take on new staff in order to manage the additional work but you are still sleepless on Wednesday nights wondering how on earth you are going to pay the payroll tomorrow.
How could you be in this position when you hadn’t had this problem for quite some time? How come you have all these additional orders but never seem to have any cash? How have you got to a position where you are going to lose your business but you have never been busier?
The answer can be very simple in that you have grown too fast and have overtraded.
Growth in a business is generally a good thing, if it is managed in a controlled manner in line with the financial resources available to the business. If it happens too quickly, without the right level of support, it can be nothing short of disastrous. The are a few basic reasons why this can occur so easily.
- You may have to make significant capital investment in production capacity in order to meet the new demand. This can take up a great deal of cash if you don’t have other means of payment such as bank funding or lease agreements
- Sales will tend to be made on credit and customers will generally tend to take longer to pay than expected, and not always just because they tend to. There may be issues with the invoice that mean it is put on hold by the customer until these issues are resolved.
- You may need to increase your stocks of raw materials, which again need to be paid for. Excess stock is quite simply your cash sitting on the shelf and has to be effectively managed to optimum levels. Too little and you let customers down, too much and you risk stock being written off and your cash along with it.
- Creditor payment terms can often be shorter than your debtor payment terms. In addition, staff wages etc have to be paid on a regular basis whether you have received payment from your customers or not.
In order to avoid the pitfalls of overtrading the following are some areas that should be managed effectively.
- Don’t just jump in with both feet when looking to grow. Forecast the impact on the business but don’t just stop with the P&L. The cash flow forecast is of vital importance in this as it will give you an idea of how much you need to fund from cash reserves at any one time.
- For example if you buy raw materials on day 1 and it takes thirty days to produce the end product, that could sit on a shelf for another thirty days. You then sell it on thirty day payment terms and all of a sudden you are funding 90 days of the total cost of that product before you are likely to see any cash. Take away the likely thirty day terms you will get from your supplier and you are looking at funding sixty days.
- Minimise how much stock you have sitting on your shelf by managing your production operations effectively so that the finished goods are sent to customers as close to completion as possible.
- Negotiate better payment terms with customers or even ask for a percentage deposit for large orders.
- Negotiate longer payment terms with suppliers so that it more closely matches your terms with customers. This can be more difficult with new suppliers but if you have managed your relationships with existing suppliers, especially by paying them on time, they are more likely to work with you.