Three Points of Growth (Part 3 of 3)

By Tom Grandy

We have been talking the last couple of months about the points of growth that have the potential of putting a company out of business. The first is when the company owner moved from the field into the office.  The second point of is when gross sales reach $1, $2.5, $5 or $10 million dollars. Each of those points of growth will require significant amounts of addition investment in the company in order to prepare for the next level of growth but usually the company does not yet have the sales to support the needed investment.

This month we are going to discuss the third and final point of growth that has the potential of closing the company’s doors.  It can happen year one, year fifth or the 55th year.  It can potentially happen every single year.  That is any point of rapid growth.  I define rapid growth as anything over 15% a year.  Now, there is a huge difference in 15% of $300,000 in gross sales and 15% of $3,000,000 in gross sales.  Does that mean you can’t grow more than 15% per year?  Of course, you can but the company better be creating a detailed month-by-month cash flow budget each year to use as the basis for adjusting their labor rates in order to maintain profitability. Be aware that any point of rapid growth will not cause gentle cash flow problems, it will cause huge cash flow problems. 

Simply stated, it takes a lot of cash (money in the bank) to run even a small business.  It takes cash to make payroll each week. It takes cash to purchase materials.  It takes cash to cover overhead costs (rent, utilities, insurance, advertising, etc.). It takes cash to fund the ever-increasing receivables.  It takes cash to pay for increased inventory as the company grows, and, it takes cash to expand the company.

The irony is that most trades companies are started by a tech that used to work for someone else.  How much cash does the typical new startup company have?  The answer is little to none.  Bingo, the average contractor begins with cash flow problems that only increase as the company grows.

Many years ago, I was presenting a full day seminar for the Mr. Electric franchise.  During one of the breaks a contractor approached me stating he had a major problem.  When I asked him what it was, he began by explaining that his company had a 30% profit.  My mind instantly said, “Ah, that’s the problem.  This contractor doesn’t understand the difference in “Gross Profit and Net Profit.”  As most reading this know, gross profit is what is left after the company subtracts the cost of labor and materials (cost of goods) from the sales dollars.  Net Profit is what is left after cost of goods AND overhead costs are subtracted from sales.  Stated another way, Net Profit is what is left after all expenses are paid.

I verbalized this to the contractor.  His response blew me away.  He stated that the company actually had a “net” profit of 30%.  After everything was paid, they had 30% left.  I responded by asking him “Then what’s the problem?”  He went on to explain that his company had literally quadrupled sales over the past nine months and that if he couldn’t secure a loan, and/or a line of credit, by the end of the week he was going to have to close his doors. 

Cash flow, or in reality, the lack of cash flow puts more companies out of business than any other single item, except improper labor pricing.  Most companies try to overcome the lack of cash flow by creating a line of credit with the bank, and/or using their distributor as their bank.  How you might ask?  By delaying payment for parts and equipment and using that money to cover the cash flow items we discussed earlier.  The problem with both is obvious.  Receivables and inventory WILL grow as the company grows.  At some point the line of credit will be maxed out and the company will be placed on C.O.D by their distributor. Need I say more?

There you have it, the three major points of growth that have the potential of putting the company out of business.  The first growth problem occurs when the owner moves from the field into the office.  The second bump in the road is when gross sales reach a $1, $2.5, $5 or $10 dollar a year.  Finally, it’s rapid growth that creates major cash flow issues.

When it comes to growth, be proactive.  Be totally aware of the company’s ever-changing costs of doing business and adjust your hourly rates as needed to maintain profitability.

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