Managing Revenue Growth
A recent survey conducted by PriceWaterhouseCooper found that 48% of the CEO’s from 1,200 respondent companies are “confident they will experience revenue growth”.
As the economy begins to slowly rebound and economic activity begins to increase demand at your company, the subject of growth is a welcomed topic of discussion. It’s been a while since most companies were required to plan for it. Business owners, managers, employees, etc. in several industries are becoming optimistic about increases in revenues after several years of decline. While it is imperative that we seize the opportunities that are created with an economic upturn, it is just as important to think about the results we want to achieve with the increased revenues. The natural tendency will be a rush to maximize any growth opportunities. The need to “make up” what has been lost in recent years will feed this tendency. The thought process of increased market share must bring with it increased profits and cash will drive companies to fuel new growth as fast as and as far as new opportunities will let them.
From a financial prospective, rapid growth can be just as devastating as negative, or no, growth. Without a viable financial plan in place, unmanaged rapid growth can drive a company to a unsustainable level of activity. This could result in the company’s cash needs far exceeding the cash available to meet those needs (sounds dangerous, doesn’t it?). Eventually, external forces will begin to curtail, or stifle, your growth. These forces exist in a variety of areas. For example, lender imposed leverage and liquidity ratios will begin to constrain the growth cycle. Or, vendors and suppliers may begin to limit your credit purchases. When these external constraints begin to slow your growth, you may be at, or have passed by, your tipping point. To grow effectively, a company must have a plan that considers a growth rate that is both obtainable and profitable.
One of the best explanations of managed growth I’ve seen is one from Elliot Smith, professor of Finance at Boston College. Mr. Smith was lecturing at a seminar I attended a few years ago, back when growth was an issue for many industries. He addressed this issue in the following manner:
” Increased sales require more assets of all types, which must be paid for. Increased assets must be funded by increases in owner’s equity (through profit retention) as well as additional borrowing. Funding of this nature will be limited. Therefore, unless the company is prepared to issue additional equity to investors, this limit places a constraint on the rate of growth a company can achieve. This constrained rate is the firms sustainable growth rate”.
As we know, most mid size companies are unable or unwilling to offer equity to outside investors. Therefore, as Mr. Smith points out, the funding of growth must come from the elements of profitability and borrowing. According to Mr. Smith, a company’s sustainable growth rate is the maximum rate at which company sales can increase without depleting financial resources. Mr. Smith continues on, offering an equation to calculate the SGR, but that is not the focus of our discussion. The important take away is this: Be careful not to get caught up in the mind set of growth at any cost. A significant increase in sales typically means the company may have a decrease in cash, which stresses the infrastructure of the company exponentially. Revenue growth, for growths sake alone, does not add value to a company. Managed, controlled growth executed with a sound operational and financial plan, will. You will be rewarded based on the execution and performance of that plan.