The start of the new calendar year has brought with it a never-ending number of corporate collapses with the likes of Dick Smith, Laura Ashley and Australian Renewable Fuels all being reported in recent weeks.
I was recently asked why this was the case. Was it the time of year? Was it that businesses are growing too fast and did this come down to the ego of the owner or chief executive? Or was it that management just doesn’t get it?
My answer was, yes to all of the above. Let me deal with each of these.
Time of year?
I think it can be the case that for some businesses the run-up to Christmas is their best time for sales. This brings with it the wish or hope that “if we can just get through Christmas everything will be OK”. Unfortunately, unless the fundamentals of the business are sound, the festive season’s trading doesn’t end up being the panacea that may have been hoped for.
If a business looks like a dog, behaves like a dog and barks like a dog – then it’s probably a dog, no matter what time of the year.
Ego – is it a dirty word?
As the saying goes – turnover (sales) is vanity, profit is sanity and cash flow is reality.
Unfortunately, based on my 30 years’ experience, sales growth can often be driven by the ego of the owner or chief executive. Here’s how – “look how good I am”, “we’ve doubled sales in three years”, “business is booming” – all mindsets that feed the ego. And this is fed by the media, with a growing stream of stories about this month’s fast-growing business, only to be next month’s corporate collapse.
What many of these businesses fail to realise is that a fast-growing business is in dangerous territory. There is often a focus on growing the top line (sales). There is less focus on whether the business is profitable and even less focus on how the growth is going to be funded – the cash flow.
Fundamentally, there is only one reason businesses fail – they run out of cash. You can have all the sales you like, but if you don’t have cash you’re out of business. There seems to be this mistaken belief that sales growth will magically fund itself.
Or is it just plain ignorance?
A business owner said to me recently: “You know, we don’t know what we don’t know.” What he meant was that he was blissfully unaware of the key things he needed to know in order to run a successful business.
He had no idea whether his business was performing well. He had no key metrics on which to assess performance. Clearly not all businesses are like this but it begs the question whether failed businesses are measuring and managing the key aspects of their business.
As mentioned previously, there is only one reason businesses fail – they run out of cash. There are three reasons they run out of cash – they grow too fast, they use operating working capital to buy long-term assets (e.g. plant) or they simply aren’t profitable. The key is to ensure you don’t fall into one of these three categories by undertaking good business hygiene.
The sad part is that in the vast majority of cases, business failure can be prevented if owners and chief executives focus on a few key parameters. Here are my key parameters to prevent your business becoming a statistic:
- Leave your ego at the door. Growth is important, but unless you have the cash to fund that growth you’ll go broke.
- Know your Return on Capital Employed (ROCE). You’ve got money invested in your business that needs to generate a return. Know how much you’ve got invested and what ROCE you’re achieving and what the drivers are to improve your ROCE.
- Every business has a Sustainable Growth Rate – know yours. This is the rate at which your business can grow without adversely affecting your debt/equity ratio.
- Watch your Free Cash Flow like a hawk. Free Cash Flow is simply the amount of cash you have left over out of your profit after funding growth. Many failed fast-growing businesses have negative free cash flow and that is why they fail. If you’re a fast-growing business and you’re not measuring and managing this you could be headed for disaster.
- Know your Working Capital Burn Rate. Sales growth generally doesn’t fund itself. Know how much additional working capital you need for a given increase in sales. Don’t budget for sales growth in the next year unless you also know this key metric.
If you aren’t being provided with this information and managing it properly, you’re flying blind.
Grant Field works as a business advisor with a number of high growth companies assisting them to achieve a sustainable high growth performance. For more information on our business advisory or accounting services please contact us.
This article originally appeared in The Sydney Morning Herald, The Age, WA Today, Canberra times and Brisbane Times