Owners need to adjust
when sales pick up

business builder banking

Since the economy started to falter, most business owners have struggled to manage their businesses differently. Many didn’t react quickly enough, and have ended up out of business or taken over. Those who have managed to stay afloat have had to walk the fine line of trimming the fat from their operations without cutting into the muscle.

As a result, many managers find that they are now overseeing a fundamentally stronger organization. Cyclical downturns can be good for the business survivors, since competitors are weeded out and only the strong survive.

The next hurdle facing many business managers will be changing from managing their businesses defensively to managing them offensively. After years with a “hunker down” mentality, a recovery can present great opportunities for those who are prepared for it.

Managing through a period of recovery can be as difficult as managing through a recession. After struggling with tight operations, an economic recovery might sound like a dream come true — increasing revenue, margins and profits. But it’s important to beware of wolves in sheep’s clothing.

In my experience, the greater the rate of recovery, the greater the risk in successfully navigating it. In other words, the faster revenue grows, the more risks exist.

Hidden challenges

The challenges of growth management come in many different forms, some obvious and others hidden. For example, new levels of investment to finance the growth, such as allocating more money in inventory, accounts receivable, labor and capacity, consume a great deal of cash. If not managed wisely, this investment can run a business out of cash faster than the growth in revenue can return it. Business owners need to be prepared for a delay in revenue return, noting very carefully how it will impact their cash flow. Cash is king, and running out, even for a very short time, is a sure-fire recipe for trouble.

Keep in mind, profits might be at record levels, but there may be very little cash in the till. The truth is that in periods of growth, this is quite often what happens. Much of a business’s cash is consumed in order to finance the increased level of revenue. A good banker or financial counselor watches for this and will caution businesses against growing too fast.

When the recovery begins in earnest, revenue will increase and the investment in raw materials, capitalized labor, finished goods, accounts receivable, deferred maintenance and capacity will consume a great deal of cash. However, if a business is not managed properly, a rapid, uncontrolled outlay of cash may limit the ability to solicit additional capital to help shore up growth.

The good news is that there are ways to finance the necessary capital. Increasing inventory turns and accounts receivable turns, slowing payment of accounts payable and so on, can raise capital. However, focusing on inventory and receivable turns is difficult to do when trying to capture profitable business that is suddenly available. In addition, creditors do not typically appreciate slow repayments, for they are often experiencing a similar cash crunch themselves.

Generally, the best route is through bank financing. However, given that banks are only able to fund timing differences or a cash flow stream produced by a plant or piece of equipment, this is tricky work for most business managers. During recessions, most surviving businesses focus on every tool available to them to trim expenses, including layoffs, downsizing of capacity and the like. During recoveries, banks tend to provide tangible business assets.

This seems logical enough, but here lies a real challenge. Banks almost always discount collateral in order to safely cover the loan balances, with accounts receivable generally advanced at 80 percent, inventory at 50 percent, and the net book value of equipment at 50 percent. Therefore, every dollar of growth in accounts receivable only finances between 50 cents and 80 cents. Consequently, the capacity of business to internally finance growth will be depleted very quickly.

Smart planning can help determine a business’s capacity to borrow, which in turn helps control revenue growth. Logical financial partners such as banks will certainly focus on profitability and cash flow, but a good business plan can ensure that the collateral coverage available to lenders is properly managed and maintained. A good understanding of these principles and a winning financial partner can mitigate the stresses of managing a business in a newly expanding economy and position any company for sustained, profitable growth.

Limit surprises

Here are some straightforward steps to limit the surprises that can hamper a business:

• Prepare a monthly forecast for 12 months ahead. Continue to update the forecast each month so it is as accurate and up-to-date as possible.
• Include a cash budget as a part of any forecasting. The cash budget will forecast cash needs on a monthly basis so you can determine if you will have enough to finance the revenue at the projected level.
• Work closely with your CPA or financial adviser. Review the validity of the projections to make sure they are prepared properly and include the appropriate assumptions.
• Seek the counsel of an experienced banker. A good banker can review forecasts and provide feedback as to the bank’s level of support. He or she can tell how much financing a bank can provide, and even whether or not that level should be sufficient for the forecasted needs.

There are many challenges that a recovery can create, so it’s important to keep a lookout for the cloud beneath the silver living. Coupled with good financial partners, these tips should make business management in a recovering economy a challenging but ultimately successful venture.