If you are having a cash flow problem today, growing your business will probably make your cash flow problem worse.
Sounds counterintuitive, right? Once you understand your current cash flow problems and once you understand what happens during business growth, I promise you a face-palm moment on this one!
First, let’s talk about your cash flow problem. Do you know why you have one? If you don’t know why, you’ll never, ever, ever be able to fix it.
Cash flow is not the same as profit. If you have more expenses than you do revenue, you don’t have a cash flow problem. You have a going concern problem. A cash flow problem is not having enough cash to pay bills when they are due although your revenues exceed your expenses.
Many things cause cash flow problems, but all cash flow problems fall into these two categories:
- Poor management of cash inflows (not collecting accounts receivable) and outflows (too much cash tied up in inventory, too much debt service)
- Poor timing of cash inflows and outflows. This occurs when your revenue model and/or sales cycle is so out of sync with the cash needs of your business, and you operate in feast-or-famine mode.
If you have the two problems above, a bigger business will only make your cash flow problems worse.
Second, you need to understand the difference between more sales and growing your business.
Growing your business is not the same thing as increased sales. I’m defining “business growth” as expansion. Meaning, not only do your sales increase when you grow your business, but so does your overhead. When you grow your business, or expand, you hire more employees and/or take on more fixed expenses such as rent for retail, manufacturing or distribution space.
Sales without expansion is always your best bet to increase profits and cash flow. If you can increase your sales with your current infrastructure, i.e. your current expenses, then do this before expanding. This means you have idle capacity in the form of some of all of these revenue-producing assets
- Employees earning a fixed salary who could sell more or service more customers
- Inventory already paid for and in place that can be sold in an already-established sales and distribution channel
- A brick-and-mortar store that can serve more customers during already-established business hours without hiring more staff or increasing staff hours
- A brick-and-mortar store than can increase the average customer ticket. For example, you own a coffee shop and the average spend per customer is $5. You can increase that to $10 with upselling (but without having to buy more inventory).
Increasing sales using your current infrastructure and overhead is just like FREE MONEY. It’s definitely money you are leaving on the table. And you need to take all the money off the table before you consider growing your business.
Now finally, let’s talk about why growing your business could be a very bad idea if you don’t know what you’re doing. Bigger is not always better. Less can be more.
We’ve already established that you should not grow your business until you 1) understand why you have cash flow problems and 2) fix them.
And you now also understand that you need to make sure you have maxed out your sales using your current infrastructure before you invest cash into growing your business.
Okay. Your cash flow problems are solved and you’ve maxed out your sales. It’s time to expand! Not so fast. Growing your business could actually make your business unprofitable. The reason? The phenomenon of scale and the risk of creating diseconomies of scale. Read the two definitions below to understand.
Economies of scale Economies of scale is the cost advantage that arises with increased output of a product. Economies of scale arise because of the inverse relationship between the quantity produced and per-unit fixed costs; i.e. the greater the quantity of a good produced, the lower the per-unit fixed cost because these costs are spread out over a larger number of goods. Economies of scale may also reduce variable costs per unit because of operational efficiencies and synergies.
Diseconomies of scale In economics, diseconomies of scale describes the phenomenon that occurs when a firm experiences increasing marginal costs per additional unit of output. It is the opposite of economies of scale. This is usually caused by an deployment problem with some of the factors of production, such as overcrowding in a factory or mismatches in optimal outputs of separate operations. Economic theorists have long believed that firms can become inefficient if they become too large. For any given combination of the factors of production (land, labor and capital equipment), there is an optimal scale for operational efficiency. Firms that outgrow their optimum scales cease experiencing economies of scale and begin experiencing diseconomies of scale.
Before you grow your business, you need to be an expert in your industry and learn everything you can about how to manage the expansion – more employees, more manufacturing, more stores, more customer service, etc. The next thing you need to know without a doubt are the financial numbers of expanding. If it costs you $1.50 to serve a cup of coffee to a current customer, don’t assume it will cost you the same amount to serve a cup of coffee to a new customer obtained through expansion. You need to analyze and account for every cost of every move you make in the expanded business.
Solve your cash flow problems and max out your sales before growing your business. You may surprise yourself and find that fixing these two issues brings you the business you always dreamed of. Sometimes you should be the hare, and sometimes you should be the tortoise.