Business growth – managing the overtrading risk
June 15, 2021
Managing growth when coming out of economic downturn
Growth kills more companies as they emerge from an economic downturn than the recession itself. More precisely, headlong expansion with depleted working capital is what does for them. After the slump, the losses and the gloom of it all, what entrepreneur would turn away that heady surge in sales?
The answer is a wise one and one with a good finance man at their side, reminding them regularly that growing sales without the funding necessary to support the increased turnover is a short road to disaster.
The Working Capital Conundrum
Many managers make the mistake of thinking that provided sales are profitable, there will be no cash flow issues. The timescales will vary from business to business, but there will nearly always be some time lag between taking an order and turning it into a sale and then receiving payment for it.
In that gap, costs are incurred. Wages have to be paid, materials or services are purchased, delivery costs (physical or digital) are incurred. The longer the ‘production’ cycle, the greater the cash outflow. If the credit terms from your suppliers are tighter than those you give to your customers, that only makes matters worse.
The faster sales rise, the more working capital is needed. Without adequate and flexible working capital resources, cash will always be a problem.
Business growth considerations
Some key considerations for any business owner:
Even if working capital is sufficient, profit margins are key in the growth phase after a recession. Being the classic busy fool, booking more and more sales at low margins is another error, or at least it is if your margins are lower than usual. The smaller the profit, the greater the cash flow strain.
2. Bad debts
As they head into the growth phase, managers must be mindful of the potential fragility of their existing customer base and any new customers. As we comment below, the financial information in the public domain right now will be seriously out of date for most businesses and are likely to cover trading periods from a very different pre-pandemic commercial world. Taking credit decisions has never been more difficult. It is always worth remembering that a business with a 10% profit margin must do an extra £100,000 in sales to make good a £10,000 bad debt.
Beware also if the growth also means committing to new equipment, facilities or premises, or to extra fixed costs such as the labour to man extra shifts. This too has to be financed somehow, which will increase the debt burden and reduce the strength of your balance sheet.
4. Borrowing for growth
Under normal circumstances, there is no problem with borrowing to support profitable growth or expansion with good medium-term prospects, always provided that your balance sheet can take the strain. After normal recessions, this can be trickier because funders are more risk-averse after suffering losses in the downturn.
This time round and post-pandemic, there is an altogether different problem. Not only has there been unprecedented commercial disruption, but there has also been an extraordinary splurge of borrowing under the government’s various Coronavirus Loan schemes. All told, over £70bn has been advanced to 1.53m businesses, or 38% of all active UK registered companies. The average Bounce Back Loan taken out has been £30,390.
No matter how relaxed the repayment terms may deliberately and rightly be, this money will have to be repaid eventually and will in most cases be a negative factor in a company’s financial profile both in terms of restricting future borrowing capacity and limiting the amount of trade credit available to it.
5. Financial information
Another crucial factor in raising money to support growth is being able to provide real-time financial data to potential lenders. The pandemic has been a data disaster for the credit market across the board, with the government extending the filing deadlines for financial statements to ease pressure on struggling companies. As a result, not only will the present commercial reality be totally different to pre-pandemic conditions but the information in the public domain is even more out of date than it normally is.
What businesses have ready and constantly updated is up-to-date management information and comprehensive financial forecasts going forward, based on assumptions that are credible under the changed circumstances in which companies are now operating.
6. Taking action early
Speed is of the essence as trading conditions ease and sales start to rise. The sooner steps are taken either to raise additional finance either by way of additional equity or further borrowing, or to put a cap on growth, the better. This is not least because the appetite and capacity of lenders will inevitability be reduced after the pandemic and with the huge extra lending commitments they have been obliged to make under the government schemes. This will be very much a case of first come, first serve.
7. Getting independent advice
Restricting growth takes remarkable objectivity, as does committing to extra debt burdens. Many owners and managers are simply too close to their businesses, or too heavily involved in their day-to-day tasks to make such important strategic decisions. Calling in outside experts can be a sensible and wise choice, even if only to have someone with experience of these difficult situations with whom to debate options.
How can Opus help?
If your business is facing growth issues, we are here to help you to find the best way forward. We are comfortable with the issues involved and we love assisting people to make good choices in these circumstances. Our ethos is to work with people to find solutions, not to lecture them or impose our ideas. Our Partners can be contacted at your nearest office.