Self Funded Growth

Just how fast can your business afford to Grow and remain Self Funding? Unplanned funding is always expensive!

The Basic Concept

We know of the well documented failures of pure .com start-ups, but what was the story behind those bricks and mortar businesses, nimble enough to adopt a new channel, wise enough to maintain their traditional cash-cow. People laughed when they were told these businesses grew themselves into bankruptcy. Since consumption is the life blood of Wall Street, any cautioning voice seems muffled, so make sure you read on or better still search for the paper of Neil C. Churchill and John Mullins published in 2001 in the HBR 2001 May edition. "How Fast Can Your Company Afford to Grow?

SFG and your Cash Operating Cycle!

Understanding self-funded growth is a great exercise in and of itself Why?

• Well instead of having an informed opinion or an instinct that accelerating growth can cause you headaches, now you can quantify your constraints.
• You will know what sets of actions you can take (apart from slowing growth or turning business away!) to alleviate your constraints.
• You will know how to direct your team appropriately and prioritize what needs to be done better.
• You know to keep an eye on how the fixed assets you finance this year can constrain you unexpectedly later on.
• You'll never have to go and raise money from an external source, which is time consuming, emotionally draining, and value destroying.
• You will appreciate the value of having some standardization instead of multiple product lines and customized service for those large "valuable" customers.
• Perhaps you will appreciate more the smaller customers that allow you to grow without stressing the business.
• Now you will treat a little more skeptically the Sales and Business Development folk planning delivery of that one really large account.
• But perhaps most importantly you are better equipped to weather any unexpected shock or "Black Swan" event.

What follows is a summary of some parts of their original paper and extra detail in other parts. For those of you who mock MBAs (none do more than I), this is a good example of why MBAs can be good. This is one of the papers I have kept from my year at INSEAD, and is my own personal copy from my lecture notes.

Asking the right questions

We agree that it takes money to make money. A business, even one with a tight, scalable business model will consume more cash in its growth phase, than in its steady state.Unlike those instances when we claim certainty to the fact that the world is round and revolves around the sun until our kids demand proof, which we cannot provide let's get into some necessary detail in the pursuit of growing your business!

There are two questions that require answers:

• for what period of time is your company's money tied up in inventory and other current assets before customers pay for the end product or services? 
• what amount of cash is needed to finance each unit of sales and what is the amount of cash generated by each ZAR of sales?

By the way, my first real life encounter with this was at a service company, so don't be fooled that this only happens to manufacturers and those needing large fixed asset investment. Any business that services a government institution must be wary of this, as terms of payment that are months long, will kill you. Now after reading this you will appreciate why some of us insist the easiest way for the government to support SMEs is to ensure terms of payment within 14 days of delivery for any government department.

Terminology & Acronyms

This looks all muddled but the general case must cater for the different combinations that various businesses have, some must pay for their inventory before receiving it, and others can pay later.

• SFG - Self Financing Growth Rate- the rate at which growth can be sustained by cash generated by the business itself without any external source of funding

• OCC - Operating Cash Cycle - the period of time between starting assembly of all the required inputs into the production line, and when the cash is handed over back to the business as payment for the sale. The sale ie the customer has the actual product or uses the service well before the business receives payment. This difference is referred to Accounts Receivable Days. Like wise the time at which your production starts, having received inventory, and the moment your business pays for this inventory is the Accounts Payable Days

• CCC - Cash Conversion Cycle - the period of time that working capital is tied up. The time between when it was converted from legal tender into one of the inputs for the production line,  and when the product converted it back to tangible cash handed to you when customers paid you in real money! or the difference in time between OCC - Operating Cash Cycle and Account Payable Days.

You will observe that different products have different inputs, different production times, and even different terms of payment for large customers. These variations need to be kept to as few as possible

If we fill in our original as-is timing diagram, we get the following:

Cycle Components	Days
Days Holding Inventory	80
Days Account Receivable	70
OCC	150
Days Account Payable	(30)
CCC	120
Operating Expenses	75

We still need to account for the OpEx - Salaries, Utilities, Rent, Marketing Costs, we can safely assume (but check this for your business) that bills arrive uniformly over the 150 day OCC period, meaning some will be paid immediately (Day 150) or have to wait (Day 1), on average this is 75 days. So now we know for how long  the cash is tied up, now we just have to see how much is tied up.

You should now interpret the information as follows. The OCC is 150 days, but because the business has 30 days to pay the suppliers, the CCC is 120 days, in other words the cash is only tied up for 120/150 of the time ie 80% of the time. Like wise for the Operating expense where we assumed a uniform distribution over the period and that some would be paid immediately and some would have to wait for the cycle to finish 150 days, on average it is 75 days or 50% of the OCC

Using the ratios we had above in the original income statement we can now answer the following: what amount of cash is needed to finance each unit of sales and what is the amount of cash generated by each ZAR of sales?

You now know a lot about your business!

17.3% growth, self funded is not bad, but things rarely go as we plan, in which case, what can we do to improve this. We have already mentioned shortening the AR Days, decreasing Inventory Holding Days, or negotiating better AP days with suppliers, are there more tactics available and which has the greatest impact?

Meanwhile consider the impact of something pretty easy, and which might even go unnoticed in the business

If we just shorten our accounts Receivable days from 70 to 30 days, perfectly reasonable, what impact would that have?

1. The OCC is now = 150 - 40 = 110 days
2. CCC is 110-30 = 80 days
3. Cash needed for Cost of Sales is = 0.60 * 80/110 = 43 cents
4. We have not targeted operating costs yet = 18 cents
5. Round everything up and we now need 62 cents instead of 66 cents (6% improvement)
6. Your per cycle growth rate is 5 cents/ 62 cents = 8% growth rate
7. How many cycles can you do in a year now? 365/110 = 3.3 cycles up from 2.43! (36% improvement!)
8. Add a contingency of 95% gives us 3.13 cycles
9. Compounded over a year we now get (1+ SFG) nbr of cycles – 1) = (1 +0.08) ^3.1 -1) = 26% from 17% originally!

Key Takeaways for you to consider

• That large corporate account you cherish and of which some sales rep is overly proud they landed, may well be actually destroying value in your business; large corporate accounts get over-serviced (and I doubt you allocate those costs properly) and pay you late!
• Growing with a greater number of smaller customers, steadily over time, within your means and without being bullied delivers more value and less stress.
• There are easy and clever ways to add lots of value to your business, that cost very little to implement, but do require an understanding of how cash gets tied up.
• No entrepreneur or single star corporate manager is ever great at all of Sales, Production, Operations and Cash Management, so get people who can complement your skill set, and allow you to do what you enjoy!