Rapid changes to the market can provide significant growth opportunities however if you dive in too quickly, the growth may be more harmful to your business than beneficial. This video covers understanding the impact of rapid growth on your cash flow, how to fund the required increase in assets, and how to measure the long-term effects on your business’s finances.
Welcome to today’s webinar on ‘Sustainable growth’, the final in our ‘Getting back to business in 2021’ series. My name is Rob Lockhart, and I will be your host for the next 20 minutes or so. 2020 was an interesting year for most people. There were changes to the way we work, the way we source entertainment, the way we socialise, the things we buy, and the way we buy them. Affecting us personally but also affecting our businesses and customers.
Some businesses faced significant challenges however others got through 2020 experiencing a growth in sales and are keen to continue that growth into 2021. Some businesses though find that along with more sales, comes growing pains - maybe profits are not growing as quickly, cash flow is suffering or there just doesn’t seem to be enough money to keep the growth going.
Today we are going to look at why that may happen this year and some of the things that may help you to make your growth successful and sustainable.
As I said my name is Rob Lockhart. I started out my career many years ago as an accountant working with a mid-tier accounting firm, here in my hometown of Sydney. I probably found I was little boring to be an accountant, so I moved out of accounting into banking. Suddenly I had the best of both worlds, I was boring and despised by most people. But I have always believed if I can help other people be more successful, I will be more successful.
And that’s pretty much how life’s turned out for me and why I got involved with Westpac’s Davidson Institute. Because webinars like this and the other material on the Davidson Institute website are a great way for people to understand the story behind the numbers in their lives and businesses, so they can make more confident financial decisions and hopefully be more successful.
Now for those who have not joined one of our webinars before, I have a few house rules to share with you. With so many people joining us today it can be noisy in the background, so we have placed you all into listen only mode. This is a live webinar, however, and I do encourage you to ask questions. Please type your questions into the questions panel. If you are on a computer, you’ll find the questions panel as part of the control panel probably on the right-hand side of your screen.
If you’re on a mobile device, it will be a ? at the top of bottom of your screen to tap on. Type them in when you think of them. I will answer your questions at the end of the presentation. We will send you an email in the next couple of days with a link to a recording of this webinar.
Before we go on, I need to let you know that the information contained in this presentation is general in nature and does not constitute advice on your personal situation. As always at Westpac’s Davidson Institute, we recommend talking to your banker, professional financial advisor or accountant for detailed information relevant to your personal circumstances.
Let’s get on with ‘Sustainable growth’. With the current changes to our operating environment your business may be one of the fortunate ones that is seeing growth in sales … or perhaps you are making changes to chase growth … either way, sales growth like this is what we want to see.
But why do we want more sales? To make more profit or, if you like, increase the return on the owner’s investment in the business. While more sales will generally mean more profit, there are several things that could impact your profit or your cash.
Basically, more sales means more customers or volume or both. To support the growing sales, you may need more goods or services; if you sell on credit you will create more debtors; you may need more resources such as staff, equipment, space and marketing; and this of course all costs money.
But you need these resources before you make your new sales, which means you may need more funding. On top of all this, if you do not maintain or improve the efficiency of these resources it could mean your profits do not grow as expected.
The key of course is to be aware of where any issues may arise and to be able to plan for them or mitigate them. Today we are going to look at: • The impact on funding and how to plan ahead for it. • Then any potential impacts on profitability and in particular your margins. • Thirdly maintaining efficiencies in the business, and finally • A quick talk about how systems and procedures can help make growth successful.
As your business grows there are more sales and more cash coming in. Then, why is it that many businesses struggle to find the cash to keep operating? It is all about timing differences and a great concept to explain this is the Financial Operating Cycle.
The Financial Operating Cycle shows how cash and profits flow through a business. By understanding how this cycle flows, it can give you some insight into how much funding you may need to grow your business. Let’s start at the beginning and imagine for a moment that we have just opened a business together. Our contribution to funding the business is called our Equity, or Net Worth. This is the money from our own pockets.
We combine that with money that we borrow, our Liabilities. Together, our money and the money that we borrow make up all of the resources that we have available to operate our business, and we operate the business by purchasing Assets. Collectively, this equation, Assets = Liabilities + Net Worth, is one of our financial statements - the Balance Sheet. The Balance Sheet shows the financial position of the business.
When we purchase Assets, we have done so to operate our business, and generate Sales. Of course, our aim is to convert those Sales into Profit through the efficient management of Expenses. This portion of the Financial Operating Cycle represents another of our financial statements the Income Statement. The Income Statement, or Profit & Loss Statement, shows the financial performance of the business.
If we have successfully made a profit, there are then 3 things we can do with it. • We could take it home by paying ourselves dividend. • We could use it to pay back our creditors or reduce debt. • Or we could use it to fund our growth through purchasing new assets.
When you are growing, it can be helpful to use most if not all of your profits to help fund that growth. However, as we saw earlier, growth requires more assets … stock, debtors, equipment etc. If your assets are growing faster than your profits, or if they’re not being managed efficiently, you may need more funding to keep your balance sheet balanced.
So, where will this funding come from? There are four main ways that you can fund growth. Remember the Balance Sheet? Assets equals Liabilities plus Net Worth. You can fund the assets required for growth either through increasing your Liabilities, or by reaching once again into your own pockets and increasing your Equity or Net Worth.
Increasing liabilities involves either taking on more debt, such as borrowing from the bank, or better leveraging the invoice terms of your creditors. In other words, holding on to those invoices until the last possible payment date, and using the money to support your growth. Increasing Net Worth can come from reinvesting any profits back into the business as we saw in the financial operating cycle, or the owners putting in more of their own money or seeking another investor or equity partner.
In our Managing Business Growth video on the Davidson Institute website, we go through a technique called Financial Gap Analysis to help estimate how much funding may be required to help make a more considered decision on where to source that funding. With funding for growth taken care of, it is now important to maximise your profit and particularly through managing your margins. If your margins decrease, you may be getting more volume but doing more work for little or no extra money.
Your Gross Profit Margin is calculated by dividing Gross Profit by Sales. Sales are the product of your price (how much you sell your goods for) multiplied by your volume (or how much of your product you sell). Your gross profit is your sales less your cost of sales. Your cost of sales can also be known as your variable costs as they will increase or decrease as your sales increase and decrease.
When you are growing, volume is driving up your sales and your cost of sales. To maintain your margins, you need to maintain the balance, or relationship, between your price and your costs.
Price is one of the most important factors in maintaining your margins. If you have dropped your price to get more sales, has your cost per sale dropped as well? Or has your margin decreased? If your margin has decreased, are you still making enough profit for the effort or work you are putting in?
Setting prices is one of the hardest things to get right in business. So, here are 5 tips to help you with pricing. 1. If you’re priced too high you may not sell enough. 2. If you are priced too low, you may not be covering your costs, or you are doing a lot of work for little profit.
3. It helps to understand the difference between pricing systems. That is mark-up versus margin. They’re different methods of pricing and can impact your profitability, particularly if they’re say included in a contract for the supply of material for unforeseen circumstances.
4. Another critical element of getting your price right is to understand your costs. How much does it cost you to get your goods or services into your customers hands? By knowing this you know have an idea of the minimum you need to charge to make a profit at a certain level of sales.
5. Finally, what is the position that you want to hold in the market? Highest quality with highest price or lowest quality with lowest price or somewhere in between? This is where your knowledge of your target market and the value they place on your goods and services is critical.
I remember a few years ago there was a coffee shop at the bottom of the building I worked in who put the prices of their coffee up by 50c each. A few weeks after that I asked the owner what the impact was on his business. And the owner said “Well, it was dreadful at first, cos a lot of customers went elsewhere” but then he found after about a week they all came back and he is now more profitable than ever.
What happened is, it turned out that one of the things his customers valued about the business was convenience. You know, not having to walk an extra block was actually worth 50c to those customers.
The other side of the margin equation is your costs. And, in particular, your stock purchasing. In short, good buying is all about having the right stock, at the right place, at the right time, at the right price.
1. Always ask for discounts and make sure you take any discounts offered. Even small discounts add up over time. 2. Don’t buy too much. Having excess stock can be costly in terms of storage, damage etc and you also run the risk of it becoming obsolete.
3. On the other hand, make sure you buy enough to cover your sales. If you run out it may be detrimental to your relationship with your customers and impact your future growth. 4. Make sure you shop around and pay the right price for the value and service you are receiving.
Another example here. A drinks manufacturer in the last few years, in an effort to reduce their costs and be environmentally friendly, purchased plastic bottles with less plastic in them. Sounds great! Unfortunately, though the bottles now felt flimsy and their customers did not like the feel, which caused their sales to drop. So, make sure you’re getting the right value for what you are paying for not just the cheapest price.
5. If your volumes are increasing, ask if there are any volume discounts, but remember not to buy too much just to get volume discounts otherwise you’ll end up with stock that you may not be able to sell. 6. Know your market and its seasonality to limit buying the right stuff at the wrong time or worse still just buying the wrong stuff. These are a few of those tips to help you with your stock purchasing.
A big area that can impact both your costs and your profitability are the efficiencies in your business. There are a number of key areas that you can look to improve efficiencies to reduce costs and improve profitability. Let’s start by looking at your cash flow efficiency.
We’re going to use a concept called the Working Capital Cycle to better understand cash flow efficiency. Every business has a Working Capital Cycle, but of course every business is different too.
We’re going to start with a nice generic one, with the cash sitting in your bank account that you use to buy something that you can sell, such as stock, time or skills. You sell the stock or a job and if you sell on credit you create debtors or accounts receivable. That is, customers who owe you money. When you collect what your customers owe you the cash comes back into your bank account with a little bit of profit attached.
The reason we are interested in this cycle is, it’s all about how long it takes for your $ to go all the way around your working capital cycle. The faster you turn the cycle, the more cash you should have available to you - allowing you to grow more rapidly, reduce the risk and cost of using short-term debt, and potentially improve your profitability.
The speed of this cycle is usually measured in days. How many days on average does your stock sit on the shelf for before you sell it? Or for service businesses, how many days from taking on and completing a job to sending out the invoice? How many days on average does it take to collect your debtors?
As you grow, you are selling more so your, stock WIP and debtors also grow. If this cycle slows down it may chew up more cash than you expect. It’s important to monitor each aspect your working capital cycle and have it turning as fast as you can. There are several articles on our website with ideas on how you can improve the speed of your Working Capital Cycle.
In addition to managing your cash flow there are other resources where improved efficiencies can often keep costs down to help improve profitability. When it comes to efficiency or productivity one of my favourite sayings is by renowned management expert Peter Drucker. “What gets measured gets managed.”
How are you going to know whether you are operating efficiently if there are no productivity measures in place? By implementing some efficiency measurements, you can then identify where things may be done more productively and implement action to improve them. There are 4 aspects to many businesses where inefficiencies commonly creep in. They’re People, Equipment, Space, and Marketing.
Firstly, in terms of people. There are many things you can measure here but 2 that I find business owners particularly like are Sales per hours worked or Sales per person – though you could also measure things like error rates or customer satisfaction rates.
If these measures raise concerns - some actions you might take to improve people productivity are things like: • ensuring people are clear on what their job is by having a good job description, • people may need to be trained to improve performance, • they may be lacking in motivation due to any number of different things, or perhaps • performance could be improved through incentives or even simple recognition.
Similarly, with equipment you could measure things like units of output per hour of operation; perhaps unit of input (either consumables such as fuel or perhaps product components) per hour of operations again; or even the amount of time the equipment is idle and not operating either due to lack of work or the equipment not being able to do the work.
Many businesses have significant $$ tied up in real estate or rent, so being able to get the most out of the space they occupy is critical. Typical measures of space efficiency are things like sales per square metre or units of production per square metre. Depending on the industry that your business operates in, things like production line efficiencies, in-store product placement, external visibility can all impact the productivity of that space that you occupy.
Finally, marketing. Again, marketing can be a significant expense so let’s make sure we are getting the best out of it. Some things to measure might be the Sales in relation to marketing costs, or perhaps the calls/contacts that can be attributed to a marketing campaign, and, of course, in this digital age, things like open rates of marketing emails or click rates on websites.
The aim here of course it to be able to identify which marketing channels are reaching and engaging your customers in a way that they then elect to spend more money with you. Even minor adjustments to any of these elements of your business can be helpful in improving efficiency, reducing costs, and improving profitability.
We have looked at funding, margins and efficiencies to help your growth be successful. One way to ensure it all happens consistently is to implement systems and procedures. With all the craziness of growth and lack of time, how do you ensure everything gets done the right way and you do not lose efficiencies?
Firstly, you document your systems and procedures. It is better if you can do this before you go through rapid growth as it may take some time. But this can be time well spent if it ensures you maximise your profit and cash during growth.
Systems and procedures manuals set out the way you do things. Having them written down helps other people learn how to do them the right way. Checklists can help here to. Remember too, to change your documentation as you find more efficient ways of doing things.
By making them easy to understand and use, and incorporating them into regular work, they do not go on a shelf gathering dust and you reap the benefits of consistency and accuracy that documentation provides.
They are can also be used when you employ new people to bring them up to speed quickly with the way you do things. When you are growing rapidly it is hard to find the time to spend with new employees and train them properly. Incorporating your systems and procedures manuals into a good induction program is one way you save time in training them.
But even with all the manuals in place, sometimes efficiencies will drop, or things get missed. Use your documented systems and procedures in ongoing training with your staff to remind them of the way to do things. Systems and procedures can help to save time and reduce mistakes helping you maintain an accurate and consistent level of service for your customers and hopefully maximise some of those profits.
Throughout today’s session we’ve looked at successfully growing your business by ensuring you are funded correctly, making sure your margins are rewarding you for the effort you are putting in, maintaining or improving your efficiencies and documenting all your systems and procedures to allow you to maintain consistent operations even when it all seems crazy with so much work to be done.
Consider what you have heard today and if you can apply it to your business to help make your growth successful and sustainable. That brings me to the end of the formal part of today’s presentation and I will now see if you have any questions for me to answer.
If you haven’t put a question in yet now is the time to start typing. As I said, if you are on a computer, you’ll find the questions panel as part of the control panel probably on the right-hand side of your screen. If you’re on a mobile device, it will be a ? at the top of bottom of your screen to tap on. Bear with me for a moment while I have a quick look to see if there are any questions.
Looks like I do have one from Mohamed. How important is internal audit for business and process improvements? That’s a very good question. Internal audits I think can be fabulous if they’re done well and in the right way. We put in place the way we do business.
Our systems and procedures, all they’re doing is saying this is the way we do business because this is the way we bring value to our customers and make sure we consistently do that, so our customers keep coming back and keep enjoying spending their money with us. Which is fabulous.
What we want to do is to make sure we keep that process going. So, it’s not a bad idea to every now and again check we’re following the processes. Now, that’s not saying that if we’ve gone off the process that’s wrong, it says we may need to change the process.
So, reviewing those processes through say an internal audit, can really help to improve those. It’s about finding the time and making sure someone’s responsible for doing it. Particularly when you’re growing.
I know that’s hard but as you’re growing particularly if you’re finding those growing pains, things aren’t working quite right, doing a little internal audit of those processes can really help you along the way. So, thank you very much for that Mohamed, great question.
Don’t seem to have any other questions at the moment. That may mean because you’re busily typing them in, which hopefully you are and hopefully it will come up before we finish today. If it comes up, I’ll answer it. But if you haven’t been able to put it in either because the technology hasn’t worked or it’s going to come to you later today or tomorrow or whenever, you can always send us a question via email.
Up on our screen in a moment, there’ll be a thank you screen with our email email@example.com. Please feel free to email us at any time. We’re quite happy to go through and answer your question if we can.
Alright, given there’s no more questions, I’m going to thank you all for your time with us today. I want to say, I hope you found this information useful and relevant and I encourage you to check out the other webinars and resources on the Davidson Institute website to help build your financial confidence.
We’d love to hear your thoughts on the webinar so there’s a short survey coming up that we’d really appreciate you taking a moment to complete. Thanks everybody again for your time and I wish you every success with your growing business. Please, enjoy the rest of your day.