"If you can look into the seeds of time, and say which grain will grow and which will not, speak then to me." - Macbeth
As Shakespeare suggests, the ability to foresee which actions will lead to growth and prosperity and which will lead to downfall is a profound skill.
EXECUTIVE SUMMARY
The term "growth" is pervasive, often becoming the focal point of discussions during earnings calls and analyst conferences.
So the question is: should a company pursue growth at any cost?
Growth can be achieved through two primary avenues:
Organic Growth, which involves expanding revenue from existing or new sources, and
Acquisition Growth, which necessitates financing.
Understanding the sources and uses of cash is paramount to ensuring a sustainable growth strategy. To promote a growth strategy effectively, the article recommends several critical steps:
Secure The Right Team: The right management team plays a pivotal role in executing the company's vision and goals.
Create The Plan: A well-thought-out plan based on historical data is crucial to determine the feasibility and funding requirements of a growth initiative.
Fund the Growth: Identifying levers for cash flow generation, such as optimizing cash velocity and leveraging assets, is essential for financing growth initiatives.
Execute The Growth: A well-structured plan must be executed effectively to achieve the desired growth.
Track Performance and Course Correct: The business landscape is dynamic, and tracking performance and adapting to changing circumstances is vital for sustaining growth.
The article underscores the need for a continuous, adaptable approach to business growth and the importance of tracking key metrics to make informed decisions early, rather than facing potential financial challenges down the road. Ultimately, the core message is to return to the basics of sound financial management to ensure a company's growth is both meaningful and sustainable.
INTRODUCTION
There is no business news publication that does not tout the word “growth”. Every earnings call or analyst conference uses a generous helping of “growth”.
Should a Company pursue “growth” at all costs? How can you ensure that the desired growth of a Company is financially sound and will not cause other challenges? In fact, what is the definition of “growth”? Should growth just represent increasing the top (revenue) line, increasing earnings, or is it increasing cash flow. If growth is represented by cash flow, is it operating cash flow or cash in the bank?
While there are many questions that one can ask, we believe that in our back to basics mantra, the answer is not difficult and very simple. Very simply, the fundamentals, if kept as such, will result in clarity of vision and understanding of a company’s intent.
Most Companies that have been in business for a while and generate steady revenue streams and earnings use the word “growth” liberally to market the organization as an attractive investment or a great Company. However growing a Company which is almost always focused on revenue is sometimes short-sighted. Growth can be achieved in two ways; organically or through acquisitions. Organic growth focuses on generating additional revenue from existing business channels or sources or adding new revenue sources which could be a new product, products or services, new markets or new relationships. Acquisitions focus on buying the ability to generate new revenue or enhancing current revenue streams. When growth is through acquisitions it often requires a financing source. The method of financing this growth is similarly using existing cash flows and or Capital or issuing new debt or new equity.
If the growth plan is not tested in depth it can lead to an unsound plan that can result in a Company going out of business. According to a survey conducted by the Turnaround Management Society on reasons for business failures, liquidity, cash flow problems and lack of financial and liquidity planning were more than 50% of the causes for business failures. In short, more companies go out of business or bankrupt due to the lack of cash flow planning or liquidity analysis than any other reason.
In order to begin the liquidity assessment, the Company needs to have a solid understanding of its sources and uses of cash. Yes, you read it right sources and uses of cash. The traditional and currently reported cash flow statement which in most cases is the indirect cash flow statement, does not help in gaining a solid understanding of a Company’s ability to generate cash. In fact, the current statement is merely an attempt to mathematically reconcile net earnings to the actual change in the Company’s cash balance. The precursor to cash flow statements was sources and uses of cash. This is a simplified version of a direct cash flow statement. Building a historical trend of the sources and uses of cash will allow a Company to understand the levers available to the Finance team to assist the plans of a Company to grow. In addition, it is important to understand the cash burn rate of a company and what are the drivers of such a burn rate. It is especially important to do so if the Company is a start-up, as there may be insufficient historical cash flows from operations upon which to assess such a burn rate; Ultimately it is the future expected cash flows that are most important.
Our view is that in every case of promoting a growth strategy, a Company should do the following:
SECURE THE CORE TEAM
Your face, my thane, is as a book where men may read strange matters. - Lady Macbeth
To state the obvious, the right management team is key to a company’s long-term success as generating positive returns consistently does not occur by itself. The right management team is aligned with the vision of the company and ensures that the appropriate resources (fit for purpose assets and appropriately skilled workforce/people) are employed/deployed to prosecute the vision and meet the goals outlined, and are managed appropriately. Then the following steps can happen with purpose.
PLAN THE GROWTH
If it were done when 'tis done, then 'twere well it were done quickly. - Macbeth
Before considering the growth, there is a need to create strong analytical models based on historical or valid data to determine the feasibility of the initiative. This may seem like an obvious step, but many companies either ignore this step or spend very little time and effort in working through all the key success factors that are needed to complete a thorough and effective plan. There should be a clear plan on how long this growth plan/initiative requires funding, what metrics will indicate if the plan is working and when the initiative will contribute to positive cumulative net cash flows.
FUND THE GROWTH
To beguile the time, Look like the time; bear welcome in your eye, Your hand, your tongue: look like the innocent flower, But be the serpent under't. - Lady Macbeth
Every Business will have the following levers of cash flow generation available:
Improving the velocity of cash generated (e.g. reducing days sales outstanding, improving stock velocity or service delivery)
Using payment terms to their advantage. If suppliers terms are net 30 there are no favours gained by paying suppliers in 15 days unless there are cash discounts available for paying earlier, and even then, magnitude of the cash discounts compared to the cost of foregoing such discounts at the benefit of using the cash on hand for greater returns elsewhere.
Ability to lever assets (e.g. Factoring receivables) in some international locations typically payments may lag beyond 30 days. Also there may be an advantage to obtain cash quicker; this should always be used with caution as some use this lever and NEVER get out of it – the rule of thumb is that this should only be used with the expectation that doing so will assist in generating increased cash over time. The day this trend goes south is the day this lever is an additional cost with no benefits. It is criminal to squander cash when the decision to take advantage of such levers are under your control.
If the company has marketable securities there may be opportunities to pledge the assets and obtain short term credit lines which can generate the additional cash required for growth. If the Company is capital intensive there may be an opportunity to borrow against the fixed assets.
Additional debt is sensible, provided the returns generated by the growth initiative surpass the cost of borrowing. This is yet another level that is often abused and in such cases leads to the cash cost of borrowing surpassing the cash returns generated.
Debt issuance typically is the second most expensive and the most expensive is equity issuance. However, this all depends on the cost of debt and the cost of capital. The interest rate environment will also create cyclical opportunities to issue debt versus equity issuance.
There are some subtleties related to private placement or issuance against existing debt or equity shelf which may lower the cost.
EXECUTE THE GROWTH
If it were done when 'tis done, then 'twere well it were done quickly. - Macbeth
We use a phrase we coined a few years ago which is an analogy for ineffectiveness in meeting a goal, “a plan without execution is like a fish without water, IT’S DEAD.” Often the balancing act of perfecting a plan and executing keeps many from fulfilling their objectives.
Often, such delays or inaction are a result of overthinking vs sticking to the basics and the drivers of what it takes to get from good to great, from small to big, from big to bigger. In business all of these objectives must revolve around ‘creating value’ for shareholders, and we continue our belief that if you can demonstrate doing so with evidence of cash generation or creation of assets and resources that have the ability to be converted into cash, then you have wasted everyone’s time, efforts, and money.
TRACK PERFORMANCE & COURSE CORRECT
I am in blood stepped in so far that, should I wade no more, Returning were as tedious as go o'er. - Lady Macbeth
The reason we did not end this article with ‘Execution’ is due to the fact that the journey that all businesses go through is continuous and do not end with ‘Execution’ as it is on-going and many times the plans are fluid and require flexibility in one’s plan of execution. The need to remain so in circumstances where external variables (e.g. interest rates, change in demands, competition, environmental and political pressures and challenges, legal actions, commodity prices, etc), is paramount, as many businesses fail to adapt or keep abreast to the factors that have a direct impact on their cash generation, thus potentially resulting in an eventual bankruptcy, or excessive uses of cash with little to no benefit.
The tracking of performance continues to be the one factor we are astonished that more businesses do not follow. Trending of key metrics that provide one with the data to plan and execute on the changes necessary to turn things around in time, rather than wait for the trend to hit rock bottom, only to have nowhere to turn, then restructure by laying off staff, discontinuing losing businesses or lower margin product lines, or worse yet, going bankrupt. Bankruptcy does not happen overnight (though some quicker than others), but over time while many hope and pray that things will turn around, instead of making the tough choices in a proactive and thoughtful way.
This is why we are adamant about tracking the performance by assessing the trends of the key metrics and taking corrective measures early to avoid what could be unfortunate but necessary decision making in the future. This is fundamental in sustaining growth.
As always, we hope that our series of articles will shine light on what should be the obvious, but often not so obvious and that we will never have to say ‘let’s go back to basics’.