If your cash flow isn’t prepared for expansion, you could go out of business
By Tom Grandy
Two major factors cause companies to go out of business: The first is improper labor pricing. Let’s assume you know your costs of doing business and what to do as costs change. Proper labor pricing is critical, and you must change your labor rate as costs change. Understanding what to charge per hour is only one piece of the puzzle, however.
The second major killer is cash flow. A company can be priced perfectly and still go out of business because of cash-flow problems. Several things affect cash flow, including the seasonality of sales and changing overhead costs. However, even if sales and overhead costs remain constant all year, receivables can still wreak havoc with cash flow. Yet while all of the above can significantly affect cash flow, they are minor in comparison to three specific stages of growth that dramatically affect cash flow. Each has the potential to put the company out of business. If you find yourself in one of the following stages of growth, stop everything and create a month-by-month, department-by-department cash-flow budget to project what your cash-flow needs will be as well as profitable pricing. Projecting monthly cash-flow needs through proper planning is the only thing that will get a company through these tight times.
The first stage of growth is when the owner moves from the field into the office: The owner stops working in the business and starts working on the business. It is an essential stage of growth and absolutely necessary for a company to increase sales. This first stage of growth is really a two-headed monster since it creates both a labor-pricing problem and a cash-flow problem. Let’s assume you are the owner and you have been working in the field with one other technician, and that you are paying yourself $30,000 a year. If the company is going to grow, you’ll have to get out of the field and run the company like a real business. The problem, however, is that the $30,000 salary you were paying yourself just changed from productive labor to overhead cost. The company now has two people in the field: the current tech and the one you hired to replace yourself. Let’s again assume both techs can bill out 75 percent of their time, which is high. That gives the company 3,120 billable hours a year. (Two techs x 2,080 hours per year x 75% billable time = 3,120 billable hours a year.) With the owner in the office, his $30,000 salary just became overhead. If you divide the owner’s salary by the billable hours, the company will have to increase its hourly rate by $9.62/hour to cover this new overhead cost while maintaining its current profitability. Normally, the owner moving from field to office creates a need for labor pricing to increase to $12 per hour. But because few companies make that kind of change in their hourly rate, the result is lower profits and significant cash-flow problems. Careful planning at this stage of growth is a must.
The next critical stage of growth occurs when you hit gross sales of $750,000 to $1.2 million. At this point, the company must make some major investments in order to reach the next level of growth. When the company approaches the $1 million in gross sales, QuickBooks is no longer sufficient. Consider purchasing a totally integrated computer system. This costs the company from $5,000 to $50,000 plus training, and sometimes at least one additional person to take care of daily data entry.
Another strange thing happens around the $1 million level. You, the owner, begin to realize you simply can’t do it all. You can’t run the crews, do all the estimates, make the sales presentations, order the materials and give the company the overall direction it requires. This level of growth will require hiring middle managers for one or more departments, and investing more in equipment and inventory. And that’s not all: You must spend more on marketing and hire more technicians. The hiring of each additional tech also increases the related overhead of gasoline, mechanical repairs, insurances and the cost of additional uniforms, plus more nonbillable time. To reach the next level of growth, the company has to make a lot of significant investments before it has the sales to support it. The end result is severe cash-flow problems. Plan carefully in the form of a monthly cash-flow budget with cash-flow projections.
The third, life-threatening stage of growth in a company can occur the first year, second year or 55th year. It can also appear multiple times in a company’s life: Rapid growth. Rapid growth is defined as any growth in excess of about 15 percent a year. Rapid growth requires more cash for inventory, receivables and increased overhead costs, not to mention the need for additional tools and equipment. Rapid growth also puts a real strain on cash flow. Believe it or not, most companies that go out of business do so in their highest volume and most profitable year. Cash flow kills them! Growing much more than 15 percent a year will cause severe cash-flow problems in your company. That does not mean a company can’t grow more than that, but if it does, a budget with monthly cash-flow projections is a must.
If you are in one of these stages, call a time out and create this budget. The real value of projecting monthly cash-flow needs through budgeting, however, is that it will buy time to prepare for the coming cash crunch. The budget will not prevent the cash crunch from coming, but it can give you enough time to plan how you will get through it. Projected cash-flow needs can be met in a variety of ways: Once you know what the cash-flow needs are going to be and when they will occur, the company may choose to hold back profits that might have otherwise been spent. It may need to set up a line of credit with the bank or perhaps increase its hourly rates to simply create more cash. The important thing is to project cash flow needs far enough in advance to allow the company time to prepare for it. If you find yourself in one of the three growth positions described, however, cash flow has the potential to put the company out of business.