10-STEPS to BUSINESS GROWTH

(By Michael J. Vail  SA Fin  FCPA, of TRE PONTE corporate, Brisbane Q’ld, on 3rd December, 2011.)

Everything in Nature, to survive, must develop, grow and produce.

To survive and thrive, on the other hand, requires they must compete, and do it better than their nearest competitor; harder, faster, stronger.   Some things grow in a linear fashion (ie, the same amount, over the same time-frame; constant growth), other things grow exponentially (eg, like a Nautilus or conch-shell, Fibonacci fashion).

Business is no different from Nature. Companies have been developed by Mankind, to facilitate trade and earn a living.   This is an intensive process; arguably a ‘hot-house’ environment, sometimes, and the competition is fierce.   Over one-third of business ‘start-ups’ fail in the first five years due to:-

• Insufficient Capital (this is the big one),
• Lack of Innovation,
• Lack of Research,
• Wrong Product, Wrong Time, or Wrong Place,
• Insufficient Skills and Experience, or
• Plain ‘old-fashioned’ Lack of Drive.

A Business Planning process would have covered all these things, for a small investment, prior to ‘investing’ the hard-earned savings.   Not as many are failing as in the past, because more people are better educated, and understand that “if you know not, and know you know not...” then they know where to ask to find out.

Industry research shows:-

• The Total number of Businesses in Australia in 2010 (per ABS) was 2,011,770; up 47,863 from the previous year, and including 286,826 business exits.
• Only 1.5% of business closed their doors in the first year of business, according to research done by VEDA Advantage (formerly Baycorp) based upon 2007-07 statistics. They said, “Most businesses face troubles in their median growth period, a stage we have defined as ‘corporate adolescence’.”
• Most problems arise in the second to fifth year, and involve problems like, “we grew too fast and ran out of cash”. This involves around 32% of start-ups.
• Some 21% wind-up between the sixth and ninth year.
• After the fourth or fifth year, the challenges diminish, for around 50% of businesses.
• This means that around two-thirds of start-ups are still continuing after 5-years, and almost one-half are still operating after 10-yeras.
• Around 7.5% of all businesses end each year, with cessation accounting for around 80%, and changes of ownership the remainder.
• The main point they stress is that most exits are not firm failures, as only 0.5% of all business exits each year are due to catastrophic failure – bankruptcy or liquidation.

It must be noted that the above figures were the result of analysis completed at the peak of that business cycle, and the numbers of firms winding-up and or going into liquidation are much higher since 2009, when the cash ‘velocity’ started to slow-down as the GFC took hold, and cash to fund future growth, and working capital became scarce.

Make no mistake, when embarking on a growth programme, it is a journey.  All journeys have a starting point, so it is important to know exactly where you are prior to commencing.  Then once you know where you are, it is easier to plan the necessary timely steps, required to arrive at your way-point, or final destination.

Business, like plants, have a ’life-cycle’, however un-like plants, in most cases the managers of a business must ensure the business entity continues by applying growth strategies, and investing in other synergies (i.e. new products, other business units, new geographical locations etc.), thereby commencing a new growth-spurt or life-cycle. The formulae to keep in mind here are:-

• “Business Planning/Goals = Growth”, and
• “Understanding, Measuring, Mitigating & Managing Risk = Sustainability”.

This constant annual tactical investment in the firm’s customer-base should show a return on investment and this ‘operational dividend’ should in-turn be largely retained by the firm, for at least the first five years, to invest in the future development and strategic growth of the business.   When a business is growing quickly, it needs to fund this growth, and without appropriate planning, may very quickly run out of cash.

Another very important fact to note about business growth is that it must grow, in real terms, and beyond the effects of inflation, to ensure the financial dividend (emanating from the business when it commences to declare a dividend), to share-holders is appropriate.   For instance, if underlying (or core) inflation is averaging 3.25% per annum, then for a business to maintain a real dividend of 4% (after tax and inflation), the firm would have to double top-line revenue every 6.83-years.

This is equivalent to a per annum increase of 10.68%; which means if net operating EBIT is $100K. at 15% profitability, turn-over is around $666K. and this figure will have to increase to $737K. an increase of $71K.; assuming the cost-structure and all else remains equal under ceteris paribus.

To achieve this growth towards profit, the most important ingredient is CASH!

A business, to appreciate the CASH! issue, must in turn, understand the:-

• • Cash-Cycle,
• • Cost of Granting Credit,
• • Businesses Cost Equation
• • Break-Even Points for Dollars and Units, for that particular level of activity.

The Cash-Cycle is the number of days from the initial sale, to having the money as cleared funds in the bank account.  Usually if your Credit Terms are 30-days, then the reality will be 45-days.   Whilst you are waiting to be paid (in a situation where the transaction has gone beyond your normal trading terms), you are paying (or foregoing) interest on your own account; you are funding their business growth.   A cash-flow budget is essential; and it should be progressively rolling forward, and measured against actual results. Always ensure to include all tax obligations in the cash-flow budget. Remember that new legislation around the granting of credit has come into force, and all firms need to address this issue, and create some policy and documentation to protect themselves.

The cost of granting credit is extra-ordinary by any measure, so you have to make it attractive for customers to pay cash or on a shorter cycle.  If you offer terms like, “2.5% / 10-Days: Nett 30”, you are saying the customer may take 2.5% off the total cost of that transaction if they pay within 10-days; else the account is fully paid within 30-days.   This is equivalent to a cash discount to the buyer, at an annualised interest rate of 13.7%.  This level of return is not available from an investment at the bank, or from most other investments, so the client may well take it up.

A business Cost Equation is derived based upon the relationship of how the numbers change in Cost Volume Profit analysis of the business on a look-forward basis, and over that level of activity.  A ‘best-fit’ equation is derived, and this may be applied, depending upon the independent variable, to ensuring an economic profit is quoted in each job-costing /quoting exercise, and in other decision-making processes.
Of all the analyses completed for a business, the Break-Even points are arguably the most important, because the business manager then knows what is the accounting and economic break-even $-Rate per Hour (or other unit of production) to achieve the previously stated goal of, “10.68% growth in top-line revenue, per annum, to achieve a 4% real return after tax and inflation”.

Therefore, to sum-up the 10-Steps to Business Growth:-

1. Have a dynamic and strategic business planning process every year; it is akin to the farmer preparing his land towards reaping the annual harvest.
2. Implement those decisions towards growth that arise from the planning process; and measure any change.
3. As a part of the business planning process, ensure you have a Marketing Plan, and allocate appropriate resources towards keeping your business front and centre of existing and future clients.
4. Have a close relationship with a quality accounting firm, and ask them what can they do for you and your business, to assist the firm to grow.
5. Retain 100% of Earnings in your business (for at least the first five years) to fund the growth, as this is the cheapest form of funding, and when you will need it most; the most expensive form of funding is selling Equity. therefore only pay yourself what the business can afford to pay you.
6. Ensure you have an appropriate Management Accounting Chart of Accounts in your Financial Accounting recording system (reconciled to Balance Sheet stage), so you have timely information at your fingertips, on reports gleaned directly from your operations. You should discuss these records with your Accountant, at least monthly.
7. Have a good relationship with the Australian Taxation Office; prepare, lodge and pay, on time. If you are having difficulty meeting your obligations, communicate early.
8. Ensure you are measuring from a real target return, else you will under-perform against any economic measures of success.
9. Understand your Cash-Cycle, and keep it short; but not at any cost.
10. Know your Accounting and Economic Break-Even Points for your current, and predicted level of activity.

Keep Growing Towards Profit!

If you would like to discuss how we may assist you to take your business forward, please call for an appointment today.

March 2011 Newsletter Article - Tre Ponte Corporate

The material and contents provided in this publication are informative in nature only.  It is not intended to be advice and you should not act specifically on the basis of this information alone.  If expert assistance is required, professional advice should be obtained.