The Handbook of Financing Growth: Strategies, Capital Structure, and M&A Transactions, Second Edition

APPENDIX D

How Fast Can Your Company Afford to Grow?

Everyone knows that starting a business requires cash, and growing a business requires even more—for working capital, facilities and equipment, and operating expenses. But few people understand that a profitable company that tries to grow too fast can run out of cash—even if its products are great successes. A key challenge for managers of any growing concern, then, is to strike the proper balance between consuming cash and generating it. Fail to strike that balance, and even a thriving company can soon find itself out of business—a victim of its own success.

Fortunately, there’s a straightforward way to calculate the growth rate a company’s current operations can sustain and, conversely, the point at which it would need to adjust operations or find new funding to support its growth. In this article, we will lay out a framework for managing growth that takes into account three critical factors:

1. A company’s operating cash cycle—the amount of time the company’s money is tied up in inventory and other current assets before the company is paid for the goods and services it produces.

2. The amount of cash needed to finance each dollar of sales, including working capital and operating expenses.

3. The amount of cash generated by each dollar of sales.

Reprinted by permission of Harvard Business Review, “How Fast Can Your Company Afford to Grow?” by Neil C. Churchill and John W. Mullins, May 2001. Copyright © 2001 Harvard Business School ...