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AN Australian-owned small business with a turnover of more than $10 million should not be going broke. So why, recently, has there been a spate of small businesses doing exactly that?
- Most businesses don't take into account that growth for growths sake is not always the best thing for the business. High growth means high risk and businesses need to surround themselves with competent financial expertise to manage that risk.
- If your financial team can't tell you what your free cash flow is, they shouldn't be there. No matter how profitable your business, you can still have negative free cash flow. This means that even if you're making a profit, your business is growing at such a rate that the profit is not sufficient to fund the growth. This means having to borrow more and more from the bank until there's a hiccup and the bank says no more.
- Know your Sustainable Growth Rate. How much can the business afford to grow without requiring disproportionate debt? Your financial team should be able to tell you what this is. Growth funded entirely on debt is dangerous growth.
- Know your working capital absorption ratio. This is a simple ratio that you particularly need to know in a high growth business. In other words, how much additional working capital is needed to fund a given increase in turnover?
- Another key reason why businesses don't have cash is that they are not profitable. It doesn't have a cash flow problem; it has a profitability problem. It may have a history of prior losses as well as the current year. These losses have to be funded from somewhere and that is usually from the shareholders, or more likely, the bank. Ultimately there comes a time when the bank says no more.
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