Article highlighting the cash flow effect of business growth

1.
Working
Capital:
The
Growth
Trap
ABC
Company
is
typical
of
many
growing
businesses.
The
business
was
commenced
in
2015.
The
owners
had
done
a
lot
of
market
research,
they
knew
their
product
was
in
demand
and
their
first
year
was
a
success.
They
started
the
business
with
a
cash
injection
of
$20,000.
In
their
first
year,
they
made
sales
of
$500,000
and
recorded
a
profit
of
$25,000
after
paying
themselves
a
salary
of
$75,000.
Their
first
years
profit
gave
them
confidence
however
they
were
concerned
that
cash
was
tight.
They
knew
that
they
had
only
‘scratched
the
surface’
of
their
market,
so
they
formed
a
budget
for
the
next
year
and
decided
that
it
would
be
possible
to
double
their
sales.
They
had
heard
that
they
needed
to
be
cautious
in
the
early
stages,
so
they
budgeted
on
giving
themselves
a
small
pay
rise.
The
second
year
budgets
projected
sales
of
$1,000,000
and
a
profit
of
$100,000
after
they
had
paid
themselves
salaries
of
$100,000.
Whilst
the
financial
performance
looked
rosy,
the
owners
couldn’t
understand
why
the
company
continued
to
be
short
of
money.
They
had
made
a
profit
in
the
first
year
and
they
were
budgeting
a
bigger
profit
in
year
two,
so
where
was
the
cash?
The
answer
lays
in
the
Balance
Sheet
and
the
Cash
Flow,
specifically
in
their
working
capital.
Working
Capital
(in
this
case)
is
defined
as:
Stock
plus
Debtors
minus
Creditors.
ABC
Company
needs
to
carry
stock
and
it
also
needs
to
offer
credit
terms
to
its
customers.
Whilst
they
were
strict
with
their
stock
controls
and
they
also
made
sure
that
they
collected
their
debtors
on
time,
the
sales
growth
meant
that
their
working
capital
(stock
and
debtors)
increased.
This
was
where
the
cash
was
tied-­‐up.
The
problem
actually
started
in
the
first
year.
Typical
of
most
businesses,
they
started
the
business
with
little
cash.
Whilst
they
made
a
profit
of
$25,000,
their
working
capital
grew
by
$84,976
over
the
course
of
the
year.
This
meant
that
their
profit
was
not
sufficient
to
cover
the
stock
and
debtor
growth
and
their
net
cash
loss
was
approximately
$60,000
In
year
two,
they
budgeted
for
a
profit
of
$100,000
however;
the
working
capital
again
increased.
The
year-­‐two
profits
are
also
not
sufficient
to
cover
the
working
capital
growth.
The
working
capital
growth
was
not
apparent
at
first
because
the
business
was
only
completing
a
profit
&
loss
projection.
It
only
became
apparent
when
the
company
projected
a
balance
sheet
and
cash
flow.

2.
What
are
the
answers?
• They
can
try
to
carry
less
stock
• They
can
tighten
their
clients
credit
terms
• They
can
slow
their
growth
They
had
been
fairly
disciplined
with
their
stock
control
and
they
were
concerned
that
they
might
upset
their
clients
if
they
tightened
terms,
so
these
were
not
considered
to
be
viable.
The
opportunity
exists
to
expand
the
business
and
the
expansion
is
profitable,
so
the
option
of
slowing
growth
is
not
palatable.
Other
options:
• Like
many
small
business
owners,
they
can
(further)
limit
their
salaries
• They
can
work
with
their
suppliers
to
secure
credit
terms
• They
can
obtain
working
capital
facilities
from
a
bank
or
other
lender.
Limiting
their
salaries
might
be
possible
however,
this
might
cause
pressure
on
their
families.
Also,
the
question
needs
to
be
asked
whether
it
is
‘right’
that
the
owners
get
paid
last.
Similarly
their
suppliers
may
agree
to
credit
terms
however,
this
might
come
at
a
cost.
Suppliers
will
give
discounts
for
up-­‐front
payments.
So
should
they
obtain
working
capital
finance
and
what
are
they
options?
Assuming
that
none
of
the
other
options
are
viable,
the
business
needs
working
capital
assistance
and
they
should
approach
a
Business
Finance
Specialist.
Potential
working
capital
funding
options
include:
1. Overdraft
2. Invoice
Finance
3. Unsecured
(short-­‐term)
funding.
In
the
next
Fact
Sheet,
we’ll
have
a
look
at
the
merits
of
each
of
these
options.
For
more
detail,
the
actual
and
budgeted
P&L,
Balance
Sheet
and
the
Cash
Flow
(with
some
supporting
comments)
are
attached
to
this
document
at
“Annexure
A”
Rob
Haynes
is
a
Business
Finance
Expert
and
is
a
Director
of
Proteger
Consulting.
Proteger
Consulting
was
formed
to
“Grow
&
Protect
Business”
through
the
provision
of
cash
flow
analysis
and
access
to
sensible
funding
solutions.

3.
Annexure
“A”:
ABC
Company
Profit
&
Loss/
Balance
Sheet
and
Cash
Flow:
ABC Company
Profit & Loss
Historical Budgeted
30/06/15 30/06/16
Revenue
Sales $500,000 $1,000,000
Total Revenue $500,000 $1,000,000
Cost of Goods Sold $300,000 $600,000
Total Cost of Sales $300,000 $600,000
Gross Profit $200,000 $400,000
Operating Expenses $100,000 $200,000
Total Operating Expenses $100,000 $200,000
Income from Operations $100,000 $200,000
Other Income (Expense)
Owners Salary -$75,000 -$100,000
Total Other Income (Expense) -$75,000 -$100,000
Net Income (Loss) $25,000 $100,000
• The
business
was
successful
in
year-­‐one,
they
made
a
profit
and
paid
themselves
a
salary
• Year
two
sales
are
forecast
to
double
• Cost
of
Goods
Sold
doubles
in
line
with
sales,
therefore
the
Gross
Profit
Margin
remains
the
same
(40%)
• Operating
expenses
double
as
they
incur
more
expenses
to
achieve
the
sales
growth
• Net
income
from
operations
increases
from
$100K
to
$200K
• The
owners
have
budgeted
to
limit
their
salary
increase
to
$25K
increasing
from
$75K
to
$100K
• Net
income
after
owners
salary
is
forecast
to
grow
from
$25K
to
$100K

4.
ABC Company
Balance Sheet
Historical Budgeted
30/06/15 30/06/16
Assets
Current Assets
Cash and cash equivalents -$39,976 -$42,710
Trade Debtors $52,100 $105,518
Inventory $32,876 $82,192
Total Current Assets $45,000 $145,000
Total $45,000 $145,000
Liabilities and Equity
Stockholder Equity
Contributed Capital $20,000 $20,000
Retained earnings $25,000 $125,000
Total Stockholder Equity $45,000 $145,000
Total $45,000 $145,000
• The
owners
contributed
$20,000
to
start
the
business
• The
business
offers
credit
terms
to
its
customers;
therefore
trade
debtors
are
$52K
at
the
end
of
year
one
and
they
are
forecast
to
grow
to
$105K
at
the
end
of
year
two.
• The
business
is
forecasting
that
debtor
collection
does
not
slow
down
• In
order
to
achieve
the
growth,
they
were
required
to
increase
their
stock
holdings.
They
carry
approx.
50-­‐days
at
cost.

5.
ABC Company - Cash Flow
Historical Budgeted
30/06/15 30/06/16
Cash Flows from Operating Activities
Operating revenues $500,000 $1,000,000
Change in Trade Debtors -$52,100 -$53,418
Cash received from customers
$447,900 $946,582
Operating expenses -$400,000 -$800,000
Cash from Owners Salary -$75,000 -$100,000
Change in Inventory -$32,876 -$49,316
Cash paid to supplies and employees
-$507,876 -$949,316
-$59,976 -$2,734
Cash Provided (Used) by Cash Flows from
Operating Activities
Cash Flows from Financing Activities
Change in Contributed Capital $20,000
$20,000
Cash Provided (Used) by Cash Flows from
Financing Activities
Net Increase (Decrease) in Cash -$39,976 -$2,734
Cash at Beginning of Period -$39,976
Cash at End of Period -$39,976 -$42,710
• The
highlighted
cells
show
where
the
cash
is
sitting.
• In
year
one,
the
business
has
‘funded’
$52,100
of
debtors
and
$32,876
of
inventory
• In
year
two,
the
business
has
‘funded’
$53,418
of
debtors
and
$49,316
of
inventory.
• Profits
were
not
sufficient
to
cover
the
working
capital
growth
in
either
year.