Just how fast can your business afford to Grow and remain Self Funding? Unplanned funding is always expensive!
We know of the well documented failures of pure .com start-ups, but what was the story behind those bricks and mortar businesses, nimble enough to adopt a new channel, wise enough to maintain their traditional cash-cow. People laughed when they were told these businesses grew themselves into bankruptcy. Since consumption is the life blood of Wall Street, any cautioning voice seems muffled, so make sure you read on or better still search for the paper of Neil C. Churchill and John Mullins published in 2001 in the HBR 2001 May edition. "How Fast Can Your Company Afford to Grow?
Understanding self-funded growth is a great exercise in and of itself Why?
What follows is a summary of some parts of their original paper and extra detail in other parts. For those of you who mock MBAs (none do more than I), this is a good example of why MBAs can be good. This is one of the papers I have kept from my year at INSEAD, and is my own personal copy from my lecture notes.
We agree that it takes money to make money. A business, even one with a tight, scalable business model will consume more cash in its growth phase, than in its steady state.Unlike those instances when we claim certainty to the fact that the world is round and revolves around the sun until our kids demand proof, which we cannot provide let's get into some necessary detail in the pursuit of growing your business!
There are two questions that require answers:
By the way, my first real life encounter with this was at a service company, so don't be fooled that this only happens to manufacturers and those needing large fixed asset investment. Any business that services a government institution must be wary of this, as terms of payment that are months long, will kill you. Now after reading this you will appreciate why some of us insist the easiest way for the government to support SMEs is to ensure terms of payment within 14 days of delivery for any government department.
This looks all muddled but the general case must cater for the different combinations that various businesses have, some must pay for their inventory before receiving it, and others can pay later.
SFG - Self Financing Growth Rate- the rate at which growth can be sustained by cash generated by the business itself without any external source of funding
OCC - Operating Cash Cycle - the period of time between starting assembly of all the required inputs into the production line, and when the cash is handed over back to the business as payment for the sale. The sale ie the customer has the actual product or uses the service well before the business receives payment. This difference is referred to Accounts Receivable Days. Like wise the time at which your production starts, having received inventory, and the moment your business pays for this inventory is the Accounts Payable Days
CCC - Cash Conversion Cycle - the period of time that working capital is tied up. The time between when it was converted from legal tender into one of the inputs for the production line, and when the product converted it back to tangible cash handed to you when customers paid you in real money! or the difference in time between OCC - Operating Cash Cycle and Account Payable Days.
You will observe that different products have different inputs, different production times, and even different terms of payment for large customers. These variations need to be kept to as few as possible