20080312 Bq Sustainable Growth

Slide 1: What growth level can your business sustain? Understanding business growth & adopting ways to manage more of it better www.businessquests.com Licensed under Creative Commons license by Business Quests.

Slide 2: 1 What you need to know 2 Case study: the QuestCo corporation 3 Conclusions

Slide 3: About sustainable growth… 1  Why is the assessment of sustainable growth relevant?  What is sustainable growth today?  How does the financial structure affect sustainable growth?  What if you proactively managed resources for growth? Licensed under Creative Commons license -3- by Business Quests.

Slide 4: Why you should assess your maximum 1 sustainable business growth  Elementary management foresight & planning  Fundamental to define your financial policy  Critical to the allocation of financial and non-financial resources  Fundamental to adequately set expectations of personnel and key partners = credibility of management  Helps you discuss financial solutions well ahead of the time when you may need them for the business  Credibility with your financial partners  Better ability to negotiate terms  Your financial structure sets the limits of your investments in future business growth  Failing to optimize the use of your resources means you will loose investment opportunities, place unnecessary financial strain on your business and put jobs in danger Licensed under Creative Commons license -4- by Business Quests.

Slide 5: What is sustainable growth today? 1  Sustainable growth is defined by limitations in  Financial resources  Access to talent both internal and external  The ability to attract customers  The effectiveness of the network of key suppliers  The competitive responsiveness of the business  The use of natural resources, esp. in context of growing pressures to tax use of scarce environmental resources  Sustainable growth is far more than the result of elaborate financial calculations, yet quantitative limits are key  Sustainable growth means growth that strengthens the business and the system to which the business belongs, including the environment, suppliers, employees, local communities…  Focus of this material is on the financial assessment of sustainable business growth Licensed under Creative Commons license -5- by Business Quests.

Slide 6: The financial structure of your business affects 1 sustainable growth in a major way  The financial structure & cycle of your business affects maximum sustainable business growth  Money tied in your inventory  Money tied in the commercial cycle as accounts receivable  Available cash (pure liquidity of business operations)  Implicit credit by suppliers as accounts payable  Some investments are compulsory & absorb financial resources  Maintenance of machines and software costs money  Replacement of productive equipments to continue operations  Discretionary investments only after the existing financial cycle and compulsory investments are funded  Discretionary investments are usually based on a specific business case and on the corporate investment policies  How will growth affect existing business activities?  How reliant is your future growth on (limited) natural resources? Licensed under Creative Commons license -6- by Business Quests.

Slide 7: Structure of balance sheet and sustainable 1 growth: the most quantitative assessment Assets = uses Liabilities = resources Tangible assets Equity Retained profits Intangible assets Inventory Long term debt Net working capital Working Accounts receivable Short term debt capital (arising from operations) Cash Accounts payable Increase of net working capital absorbs financial resources Licensed under Creative Commons license -7- by Business Quests.

Slide 8: Structure of balance sheet and sustainable 1 growth: the most quantitative assessment Assets = uses Liabilities = resources Fixed assets = committed to long term use by the business Long term financial resources Net working capital Current assets of Working business operations Current liabilities capital = working capital (arising “spontaneously” from operations) Increase of net working capital absorbs financial resources Licensed under Creative Commons license -8- by Business Quests.

Slide 9: Funding requirements stemming directly from the 1 growth of existing operations Assets = uses Liabilities = resources Fixed assets = committed to long term use by the business Long term financial resources Net working capital Current assets of Working business operations capital Current liabilities = working capital (arising “spontaneously” from operations) Growth  increase of current assets  need to fund growth of net working capital Licensed under Creative Commons license -9- by Business Quests.

Slide 10: Biggest managerial impact is through allocation 1 of resources: priorities matter a great deal! New resources Labor New New capital debt Materials General Inventory Liquidity at expenses start of FY Maintenance & Accounts replacements receivable Discretionary investments Liquidity at end of FY Retained earnings Equity Key Resources Taxes Interests returns Uses Licensed under Creative Commons license - 10 - by Business Quests.

Slide 11: What can you do to proactively manage resources 1 for growth?  Manage and optimize your net working capital:  Offer payment terms to customers in accordance with their strategic importance to your business  Make sure customers pay on the agreed terms  Negotiate the best possible payment terms with suppliers  Keep inventory under control  Optimize your cost structure  Keep fixed costs under control as they affect break-even and use of cash  Negotiate service level and cost with key suppliers  Prioritize investments  Compulsory before discretionary  Discretionary investments with best expected return first  Negotiate with financial partners to be assured to fund all growth opportunities adequately Licensed under Creative Commons license - 11 - by Business Quests.

Slide 13: Introduction to the QuestCo case study 2  QuestCo is a software development company that markets own software products and offers IT development services  Totally self-financed  High-growth resulting largely from exceptional commitment of founders and early joiners  Weak management of net working capital and “intuitive” allocation of financial resources  Key questions to assess:  how much can the business grow given its financial structure?  what are the options of management to enhance sustainable growth? Licensed under Creative Commons license - 13 - by Business Quests.

Slide 14: QuestCo’s Financials & Sustainable Growth 2 QuestCo's Financial Statements INCOME STATEMENT (IN '000) EUR % of sales Sales 13,000 100.0% Cost of sales 8,000 61.5% Gross Profit 5,000 38.5% QuestCo's Operating Cash Cycle Operating expenses 4,000 30.8% Duration Cash is Tied Up (days) Taxes 30.0% 300 2.3% Accounts receivable 95 days Net profit after tax 700 5.4% Inventory 68 days Operating Cash Cycle (OCC) 164 days BALANCE SHEET Accounts payable 41 days Cash 300 Cost of sales 123 days Accounts receivable 3,400 Operating expenses 82 days Inventory 1,500 Income statement (EUR) Total current assets 5,200 Sales € 1.000 Infrastructure & equipment 700 Total assets 5,900 Cost of sales € 0.615 Operating expenses € 0.308 Total costs € 0.923 Accounts payable 900 Profit (cash) € 0.077 Bank loan payable 1,500 Amount of Cash Tied Up per Sales Dollar (EUR) Total current liabilities 2,400 Cost of sales € 0.461 Contributed capital 150 Operations € 0.154 Retained earnings 3,300 Cash required for each OCC € 0.615 Total owner's equity 3,450 Cash Generated per Sales Dollar € 0.077 Total equities 5,850 Number of Operating Cash Cycles = 365 / OCC = 2.23 SG per OCC = Cash generated per sales dollar / Cash required per OCC = 12.51% Sustainable year on year growth = 27.8% Licensed under Creative Commons license - 14 - by Business Quests.

Slide 15: Option 1: Speeding Cash Flow 2 QuestCo's Financial Statements Option 1: Speeding Cash Flow INCOME STATEMENT (IN '000) EUR % of sales Sales 13,000 100.0% Cost of sales 8,000 61.5% Gross Profit 5,000 38.5% QuestCo's Operating Cash Cycle Operating expenses 4,000 30.8% Duration Cash is Tied Up (days) Taxes 30.0% 300 2.3% Accounts receivable 90 days Net profit after tax 700 5.4% Inventory 64 days Operating Cash Cycle (OCC) 154 days BALANCE SHEET Accounts payable 41 days Cash 300 Cost of sales 113 days Accounts receivable 3,200 Operating expenses 77 days Inventory 1,400 Income statement (EUR) Total current assets 4,900 Sales € 1.000 Infrastructure & equipment 700 Total assets 5,600 Cost of sales € 0.615 Operating expenses € 0.308 Total costs € 0.923 Accounts payable 900 Profit (cash) € 0.077 Bank loan payable 1,500 Amount of Cash Tied Up per Sales Dollar (EUR) Total current liabilities 2,400 Cost of sales € 0.451 Contributed capital 150 Operations € 0.154 Retained earnings 3,300 Cash required for each OCC € 0.605 Total owner's equity 3,450 Cash Generated per Sales Dollar € 0.077 Total equities 5,850 A 5.8% drop of current assets… …causes an 8% drop in days of cash tied up… … and an increase of sustainable growth to 30.2% up from 27.8%, i.e. an improvement of almost 8.5% Licensed under Creative Commons license - 15 - by Business Quests.

Slide 16: Option 2: Reducing Costs 2 QuestCo's Financial Statements Option 2: Reducing Costs INCOME STATEMENT (IN '000) EUR % of sales Sales 13,000 100.0% Cost of sales 7,850 60.4% Gross Profit 5,150 39.6% QuestCo's Operating Cash Cycle Operating expenses 3,960 30.5% Duration Cash is Tied Up (days) Taxes 30.0% 357 2.7% Accounts receivable 95 days Net profit after tax 833 6.4% Inventory 68 days Operating Cash Cycle (OCC) 164 days BALANCE SHEET Accounts payable 41 days Cash 300 Cost of sales 123 days Accounts receivable 3,400 Operating expenses 82 days Inventory 1,472 Income statement (EUR) Total current assets 5,172 Sales € 1.000 Infrastructure & equipment 700 Total assets 5,872 Cost of sales € 0.604 Operating expenses € 0.305 Total costs € 0.908 Accounts payable 884 Profit (cash) € 0.092 Bank loan payable 1,500 Amount of Cash Tied Up per Sales Dollar (EUR) Total current liabilities 2,384 Cost of sales € 0.452 Contributed capital 150 Operations € 0.152 Retained earnings 3,300 Cash required for each OCC € 0.605 Total owner's equity 3,450 Cash Generated per Sales Dollar € 0.092 Total equities 5,834 Reducing cost of sales by 1.9% and operating expenses by 1.5%… …dramatically improves cash generation… … which pushes sustainable growth to 33.7% up from 27.8%, i.e. an improvement of over 20% Licensed under Creative Commons license - 16 - by Business Quests.

Slide 17: Option 3: Raising prices 2 QuestCo's Financial Statements Option 3: Raising Prices INCOME STATEMENT (IN '000) EUR % of sales Sales 13,000 100.0% Cost of sales 7,882 60.6% Gross Profit 5,118 39.4% QuestCo's Operating Cash Cycle Operating expenses 3,941 30.3% Duration Cash is Tied Up (days) Taxes 30.0% 353 2.7% Accounts receivable 95 days Net profit after tax 824 6.3% Inventory 69 days Operating Cash Cycle (OCC) 165 days BALANCE SHEET Accounts payable 42 days Cash 300 Cost of sales 123 days Accounts receivable 3,400 Operating expenses 82 days Inventory 1,500 Income statement (EUR) Total current assets 5,200 Sales € 1.015 Infrastructure & equipment 700 Total assets 5,900 Cost of sales € 0.615 Operating expenses € 0.308 Total costs € 0.923 Accounts payable 900 Profit (cash) € 0.092 Bank loan payable 1,500 Amount of Cash Tied Up per Sales Dollar (EUR) Total current liabilities 2,400 Cost of sales € 0.460 Contributed capital 150 Operations € 0.154 Retained earnings 3,300 Cash required for each OCC € 0.614 Total owner's equity 3,450 Cash Generated per Sales Dollar € 0.092 Total equities 5,850 Raising prices by a mere 1.5%… …dramatically improves cash generation… … which pushes sustainable growth to 33.1% up from 27.8%, i.e. an improvement of 19% Licensed under Creative Commons license - 17 - by Business Quests.

Slide 18: What if all options were combined? 2 QuestCo's Financial Statements Pulling multiple levers INCOME STATEMENT (IN '000) EUR % of sales Sales 13,000 100.0% Cost of sales 7,850 60.4% Gross Profit 5,150 39.6% QuestCo's Operating Cash Cycle Operating expenses 3,960 30.5% Duration Cash is Tied Up (days) Taxes 30.0% 357 2.7% Accounts receivable 90 days Net profit after tax 833 6.4% Inventory 65 days Operating Cash Cycle (OCC) 155 days BALANCE SHEET Accounts payable 41 days Cash 300 Cost of sales 114 days Accounts receivable 3,200 Operating expenses 77 days Inventory 1,400 Income statement (EUR) Total current assets 4,900 Sales € 1.015 Infrastructure & equipment 700 Total assets 5,600 Cost of sales € 0.613 Operating expenses € 0.309 Total costs € 0.922 Accounts payable 884 Profit (cash) € 0.093 Bank loan payable 1,500 Amount of Cash Tied Up per Sales Dollar (EUR) Total current liabilities 2,384 Cost of sales € 0.450 Contributed capital 150 Operations € 0.155 Retained earnings 3,300 Cash required for each OCC € 0.605 Total owner's equity 3,450 Cash Generated per Sales Dollar € 0.093 Total equities 5,834 Improved cost efficiency, higher prices and reduced current assets… …dramatically improve cash usage & generation… … which pushes sustainable growth to 36.2% up from 27.8%, i.e. an improvement of almost 30% Licensed under Creative Commons license - 18 - by Business Quests.

Slide 20: Key lessons to take away 3  Optimal management of available financial & business resources can give your business an extra boost  Managing your cost structure tightly is essential and will also affect your break-even point  Measuring key aspects of financial structure helps you identify options for achieving more with existing assets  Options to consider depend on your position in the market  Negotiating position vis-à-vis suppliers  Negotiating position vis-à-vis customer  Intensity of competition  The differentiation of your business relative to competitors  Price sensitivity of your customers Licensed under Creative Commons license - 20 - by Business Quests.

Slide 21: Sustainable growth also depends on non-financial 3 factors, e.g. talent, natural resources… Growth Human capital limit to growth rate Company B sustainable growth Financial limit to growth Financial limit to growth Company A sustainable growth Environmental limit Human capital limit Environmental limit Company A Company B Licensed under Creative Commons license - 21 - by Business Quests.

Slide 22: Bibliography  Janet Kiholm Smith and Richard L. Smith, Entrepreneurial Finance, 2004, John Wiley & Sons  Neil C. Churchill and John W. Mullins, How Fast Can Your Company Afford to Grow?, May 2001, Harvard Business Review, vol. 79, no. 5 Licensed under Creative Commons license - 22 - by Business Quests.

Slide 23: Where quests of people yield value for business® Helping your business grow better www.businessquests.com Licensed under Creative Commons license by Business Quests.

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