By: Scott Clendenan, Director, Mid-Ticket Business
It is no surprise that the goal of most successful entrepreneurs is to grow both the sales and profitability of their business.
One might think that the greater the sales growth, the more a company is prospering. While that may be true in some cases, there are also some serious risks associated with rapid growth, even when the increasing revenue is raising your bottom line.
These risks can be broken down into two separate categories: operational risks and financial risks – each having its own challenges which will need to be addressed within your business.
Operational risks are those risks not directly related to the financial statement of your company. These are things like proper employee management, customer service management, and a company’s ability to effectively deliver on its value proposition.
Employee Management Pitfalls
Rapid sales growth often necessitates the need for more employees at all levels of the company, including supervisors and management.
Does your company have access to quality new employees? Does your company have adequate succession planning within your organization to manage a growing sales force (i.e. adequate new supervisors and managers)? If those elements are not in place, the quality of work can suffer, leading to possible inefficiencies and increasing customer service issues.
Let’s look at a hypothetical situation for your business. You are experiencing significant growth and workloads are increasing for all employees. Your existing and newer employees are facing more and more responsibility. Your previously well-managed operation and associated high-level customer service begins to suffer because you are unable to train or hire the right employees to match the pace of your sales growth. Your company, which prided itself on a certain quality of work, may now see a decline in both the quality and efficiency of its product due to the demands of unmanaged growth. As a result, damage to key customer relationships can occur and long-term brand loyalty may suffer.
How to Avoid Operational Risk
Ensure your business has experienced managers and supervisors who can effectively delegate new responsibilities to a qualified and capable employee group. Ensure that each group has the proper resources and time to successfully manage their responsibilities. Each group will need to remain focused on those areas of business that helped make your company successful in the first place.
Other risks of rapid sales growth are directly related to your company’s financial statement.
Increasing sales will generally require a proportionate increase in your company’s asset base. Short-term assets, such as accounts receivable and inventory, will normally increase as revenues rise. Often there is also a need for further investment in capital assets, such as new equipment and increased building space, to support growing business volumes. All of these things ultimately require cash to cover their costs.
Financing Your Asset Base
A growing asset base must be financed by some combination of new debt and new equity (normally profits). If your growth is very rapid, your new profits may not be substantial enough to maintain an appropriate level of overall leverage, typically referred to as a company’s debt to equity ratio.
In other words, if your sales growth is substantial and your asset base is growing at a similar level, you may require significant new debt, either in the form of a lease or loan, to support this growth. A well-capitalized company can quickly become a very highly leveraged company when growing quickly; and now, any sudden change in business environment could erase all of your prior positive results.
Sales growth requires increased cash. More cash is necessary for funding areas that help produce your growing account receivables and inventories. New long-term financing also means increased interest and debt servicing costs. As input costs increase, account payable balances also increase. It is vitally important to properly manage this aspect of your business, otherwise you risk damaging your relationships, and favourable terms, with your suppliers. A lessening of credit terms could further exacerbate a liquidity issue.
In summary, higher account receivables, tightened supplier terms and maximum utilization of your operating line could pave the way to a liquidity crisis, where you will lack the available cash to pay immediate bills.
How to Avoid Financial Risk
Ensure you are managing your balance sheet with sufficient working capital and equity to preserve your business’s long-term viability.
Equity and working capital should grow somewhat in proportion to your company’s sales growth. If new profits are insufficient to meet this demand, a company should consider other sources of equity – either outside investors or shareholder contributions – to maintain appropriate levels of leverage and working capital.
Operational and Financial risks pose serious threats to your business and may hinder impressive growth this year if you are unprepared. Ensure you have a strong, experienced management team and the proper capital structure in place. You will avoid pitfalls and nurture a growth-favourable environment for your business.