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chris griffiths

We all know cash is king. Many small businesses that survive the cash starvation of the startup years and make it to the comparably stable break-even stage fail to recognize the next cash-crunch phase – growth.

Recently, a potential client was referred to me with a business dilemma.

The entrepreneur's manufacturing business had struggled for several years. It had been making a small profit, but had failed to crack the next sales level that would have provided the economies of scale to really benefit from the fixed-expense structure he had created to become a bigger business.

Now, it was happening: His sales were up almost 30 per cent over the previous year, the factory was humming, and the growth he had already enjoyed this year looked like it could not only be sustained but even be improved.

Yet, this small-business owner was miserable.

Just when everything he had worked for was coming to fruition, he was out of cash – right on the heels of the best month of profit he had ever recorded. His line of credit at the bank was maxed out and his vendors were calling, wondering where their normally reliable payments were.

"I think I liked this business better when it was smaller and breaking even," he told me.

Nonsense, I assured him. This was  a phase, and what he could learn about cash-flow traps would serve him – and many other entrepreneurs – well in the future.

If you want to learn a lesson or two from this entrepreneur's experience, take note of what we found when we dug into his profit-and-loss statement from his most recent, and most profitable, month.

1. The majority of the growth in his business was coming from a small group of customers to whom he extended 60-day payment terms. He agreed to these terms a year before, because that was what he needed to offer a competitive advantage. Now he had great sales, but had to wait 60 days to get paid.

Where's this cash? In receivables, waiting for payment.

2. Since his business had grown quite suddenly, he was bumping into the credit limits of vendors – so he was paying for more and more supplies with cash, and missing out on the cushion of 30-day payments terms with these suppliers.

Where's this cash? With vendors whose credit limits are fixed.

3. Part of the growth he was experiencing was due to an OEM (original equipment manufacturer) client he had landed but the factory was making products under the client's brand, not the factory's. Landing this contract required investments in tooling and equipment specific to the client's designs, which had to be paid upfront.

Where's this cash? Tied up in fixed assets, such as equipment and tooling, that will pay off over time but represent an upfront cash investment.

4. Many of his new clients and much of his new business were being lured by new designs he and his team had created. They were fresh and contemporary.

However, the new designs required raw materials that his business had never before used. Suppliers of these materials, in some cases, had high minimum-order quantities.

So, while he needed some material to get the product launched and seeded in his sales channel, he had to order more quantity than he initially needed to get it going.

Where's this cash? Stuck in inventory levels that were artificially and, hopefully temporarily, high because of high minimum order quantities relative to existing sales.

If you look at the issues we found, they actually seem quite reasonable. This is the cash-flow pain that often comes with growth. Any one of these problems, in isolation, could seem manageable. But taken together, they created a serious cash crunch.

In the business and excitement of running his factory, this business owner failed to predict these issues far enough in advance.

Most of them can be easily overcome with advance notice and negotiation with the outside parties involved: customers regarding payment terms and custom-tooling costs, vendors about credit limits and minimum-order quantities, and banks, about your overall line of credit.

You could, for instance, negotiate an increase in your line of credit. All but the custom-tooling above could be borrowed against in a typical line of credit.

You could give vendors a heads-up in advance of growing the business and seek assurances that they could extend your credit limit, terms and lower minimum order quantities while you test new products in the market.

You could also offer prompt-pay discounts to entice customers to pay more quickly (but watch out for the margin effect, as this is usually more expensive than using your line of credit to finance the receivable).

The most important takeaway: Don't wait until you hit the cash wall to consider how growth in your business will be financed. That way, you'll actually enjoy that growth and be ready for more.

Special to The Globe and Mail

Chris Griffiths is the Toronto-based director of fine tune consulting, a boutique management consulting practice. Over the past 20 years, he has started or acquired and sold seven businesses.

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