Navigating Business Rapids - The CFO-Pro Newsletter

Business growth presents special challenges in financial planning because executives often believe growth is something to be maximized. Unfortunately, fast-growing companies that lack the financial acumen to manage their growth can and do fail.

Increased sales require more assets of all types (i.e., inventory, accounts receivable, productive capacity), which must be paid for. Retained profits and new borrowings generate some cash, but only limited amounts.

Knowing your company's sustainable growth rate can help you avoid biting off more sales than your company can chew. The sustainable growth rate is the product of four ratios:

P is profit margin % (net income / sales)
T is asset turnover ratio (sales / total assets)
R is profit retention rate % (net profit – dividends)
L is assets to equity ratio (assets / beginning equity) or leverage

Unless an owner is willing and able to sell equity or borrow money, the sustainable growth rate is a ceiling on the growth achievable without straining resources. As equity grows, a company can borrow more money without altering the capital structure. The sustainable growth rate then is nothing more than its growth rate in equity.

            $1,000,000      Last year’s sales
            $2,000,000      Total assets
            $   400,000      Beginning equity
                       10%      P
                           .5      T          ($1,000,000 / $2,000,000)
                       85%      R
                            5      L          ($2,000,000 / $400,000)

Assets, liabilities and productive capacity will expand proportionally to sustain growth in sales up to $1,212,500. Any growth greater than 21.25% will begin to strain resources—debt capacity will be reached, lenders will refuse additional credit requests, and cash will be deficient to pay bills.

Calculate your sustainable growth rate and keep an eye on your numbers. You can have too much of a good thing, whether it's turkey or sales.

The Wisdom of Henry Hazlitt (1894-1993)

There is no more persistent and influential faith in the world today than the faith in government spending. The fallacy of this faith is that all government expenditures must eventually be paid for by taxation.

The thing so great that “private capital could not have built it” has in fact been built by private capital—the capital that was expropriated in taxes, or if the money was borrowed, that eventually must be expropriated in taxes.

It is highly improbable that projects thought up by bureaucrats will provide the same net addition to wealth and welfare per dollar expended, as would have been provided by taxpayers themselves, if they had been individually permitted to buy or have made what they wanted, instead of being forced to surrender part of their earnings to the state.

— From Economics in One Lesson

Every other month, Navigating Business Rapids provides financial tools that improve bottom-line results and build business equity.

CFO-Pro can assist you in implementing these tools in your business. We specialize in identifying the causes of negative trends and ways to take corrective action.

Feel free to forward this newsletter to others and send us your questions or suggestions for future issues. Free subscriptions are available on our website, CFO-Pro.com, from the Newsletter page.

Wisdom • Insight • Experience
(630) 778-7646 • (800) 724-4578 • JLafferty@CFO-Pro.com


Navigating Business Rapids with John Lafferty, CFO-Pro
November 2008 Issue #8	Don't Bite Off More Than You Can Chew Business growth presents special challenges in financial planning because executives often believe growth is something to be maximized. Unfortunately, fast-growing companies that lack the financial acumen to manage their growth can and do fail. Increased sales require more assets of all types (i.e., inventory, accounts receivable, productive capacity), which must be paid for. Retained profits and new borrowings generate some cash, but only limited amounts. Knowing your company's sustainable growth rate can help you avoid biting off more sales than your company can chew. The sustainable growth rate is the product of four ratios: G = P x T x R x L where P is profit margin % (net income / sales) T is asset turnover ratio (sales / total assets) R is profit retention rate % (net profit – dividends) L is assets to equity ratio (assets / beginning equity) or leverage Unless an owner is willing and able to sell equity or borrow money, the sustainable growth rate is a ceiling on the growth achievable without straining resources. As equity grows, a company can borrow more money without altering the capital structure. The sustainable growth rate then is nothing more than its growth rate in equity. Here's an example of calculating a sustainable growth rate: $1,000,000 Last year’s sales $2,000,000 Total assets $ 400,000 Beginning equity 10% P .5 T ($1,000,000 / $2,000,000) 85% R 5 L ($2,000,000 / $400,000) Assuming no additional equity infusion, the sustainable growth rate is: 10% x .5 x 85% x 5 = 21.25% Assets, liabilities and productive capacity will expand proportionally to sustain growth in sales up to $1,212,500. Any growth greater than 21.25% will begin to strain resources—debt capacity will be reached, lenders will refuse additional credit requests, and cash will be deficient to pay bills. Count Your Blessings Calculate your sustainable growth rate and keep an eye on your numbers. You can have too much of a good thing, whether it's turkey or sales. The Wisdom of Henry Hazlitt (1894-1993) There is no more persistent and influential faith in the world today than the faith in government spending. The fallacy of this faith is that all government expenditures must eventually be paid for by taxation. The thing so great that “private capital could not have built it” has in fact been built by private capital—the capital that was expropriated in taxes, or if the money was borrowed, that eventually must be expropriated in taxes. It is highly improbable that projects thought up by bureaucrats will provide the same net addition to wealth and welfare per dollar expended, as would have been provided by taxpayers themselves, if they had been individually permitted to buy or have made what they wanted, instead of being forced to surrender part of their earnings to the state. — From Economics in One Lesson About Navigating Business Rapids Every other month, Navigating Business Rapids provides financial tools that improve bottom-line results and build business equity. CFO-Pro can assist you in implementing these tools in your business. We specialize in identifying the causes of negative trends and ways to take corrective action. Feel free to forward this newsletter to others and send us your questions or suggestions for future issues. Free subscriptions are available on our website, CFO-Pro.com, from the Newsletter page. Wisdom • Insight • Experience (630) 778-7646 • (800) 724-4578 • JLafferty@CFO-Pro.com
	Home \| Services \| Presentations \| FAQs \| Newsletter \| Clients Say \| About Us \| Contact Us Copyright © 2008