The Great Recession is clearly a thing of the past. The economy appears to be expanding. Businesses are seeing sales, growth, and profits. Entrepreneurs are experimenting with new products and markets, starting new divisions and making investments in people.
Growth is good. But too much of a good thing can become bad. So how do you know if you’re growing too fast? Here are five signs that you might be growing too fast.
1) You’re just about out of cash. Growth always requires cash and increases complexity. Growing companies always run in to unforeseen costs. A growing company will run tight on cash as expenditures outpace sales. Companies with inventory or receivables will run in to this situation particularly fast.
2) Management is stretched way too thin. Sooner or later, a company will grow beyond the core management team’s ability to micromanage it. As a CEO, the company you founded may be doing quite well, but you’ve never had to share decision making authority with someone else. Delegating is the number 1 challenge for CEO’s in most small businesses. Whether your company is stretched in sales, operations or financial management, you may need to delegate those responsibilities to someone who can take your company to the next level.
3) You haven’t revised your projections. You may have done projections annually, but a fast growing company should revise their projections multiple times annually as management sees major deviations (good or bad) in collections and expenditures. This updating will tell management when to slow down growth or cut expenses so you don’t run out of cash.
4) You stopped planning for taxes. As your company becomes more profitable, it’s tax bill will likely increase at a higher rate than anticipated because it will move into a higher tax bracket. Don’t get surprised a month before April 15th that you have a big tax payment to make with no cash to make it.
5) Profits fall of the radar. When a company is expanding quickly, it’s very easy to become excited about rapidly rising sales and lose track of profits. This is particularly true when the company reaches a stage where it has many managers. It’s important to keep an eye on margins.
So what’s the right amount of growth? Many financial managers use the sustainable growth rate calculation to come up with that answer. This is the maximum growth rate a firm can sustain without increasing leverage. It’s calculated as return on equity x 1 – dividend/distribution payout ratio.
So if your ROE (return on equity) is 20% and you pay out 50% of your profits as dividends or distributions, then your sustainable growth rate is 20 x .5 or 10%.
