How to Manage Growth? Company Level View Jari P. Angesleva Project Manager IFC ROSS 11.6.2004 33 The Growth Dilemma… Business growth can be a two-edged sword. When it is controlled, it usually leads to financial success. When it is uncontrolled, it can lead to financial failure. Why? Because growth: 2 • Eats cash fast, especially if you extend credit to individuals or customers and must cover their payment float while also financing your expansion; • Requires a company to "stretch" beyond their current capabilities. Sometimes this stretch can get to the breaking-point and bring a perfectly viable company down; • Requires new investment in resources--be it labor or equipment--which will invariably not be operating at full capacity and paying for itself immediately. You, the Owner! But most importantly, it requires the owner to change the way they think about both their business and the way they operate it. Over time, companies evolve, in the same way that individuals grow. What worked in your first stage of business, will not work in later stages. You, as the owner, will need to develop new skills and stop being the "doer" and start being the MANAGER and eventually, the LEADER! 3 Leading vs. Managing – Two Different Animals Are you a manager or a leader? Although you may hear these two terms thrown out interchangeably, they are in fact two very different animals complete with different personalities and world views. By learning whether you are more of a leader or more of a manager, you will gain the insight and self-confidence that comes with knowing more about yourself. The result is greater impact and effectiveness when dealing with others and running your business. Leaders and Managers First of all, let's take a look at the difference in PERSONALITY STYLES between a manager and a leader. • Managers - emphasize rationality and control; are problemsolvers (focusing on goals, resources, organization structures, or people); often ask question, "What problems have to be solved, and what are the best ways to achieve results so that people will continue to contribute to this organization?"; are persistent, tough-minded, hard working, intelligent, analytical, tolerant and have goodwill toward others. • Leaders - are perceived as brilliant, but sometimes lonely; achieve control of themselves before they try to control others; can visualize a purpose and generate value in work; are imaginative, passionate, non-conforming risk-takers. Leaders and Managers… Managers and leaders have very different attitudes toward GOALS. • Managers - adopt impersonal, almost passive, attitudes toward goals; decide upon goals based on necessity instead of desire and are therefore deeply tied to their organization's culture; tend to be reactive since they focus on current information. • Leaders - tend to be active since they envision and promote their ideas instead of reacting to current situations; shape ideas instead of responding to them; have a personal orientation toward goals; provide a vision that alters the way people think about what is desirable, possible, and necessary. Question? Are you a LEADER or MANAGER? If you are running your own business, you must develop management skills, whether they come naturally or not. However, what do you do if you believe you are, in fact, a leader - a diamond in the rough? What can you do to develop as a leader? Throughout history, it has been shown again and again that leaders have needed strong one-to-one relationships with teachers whose strengths lie in cultivating talent in order to reach their full potential. If you think you are a leader at heart, find a teacher that you admire - someone who you can connect with and who can help you develop your natural talents and interests. Whether you reach "glory" status or not, you will grow in ways you never even imagined. And isn't that what life is about anyway? What Are Some of the Potential Problems That Occur When Sales Soar? You are understaffed and HIRE IN HURRY! • How do you select the right person for your business? • There is no perfect answer, but the interview process can be a tremendous help if you use it effectively. In other words, you must have completed all of the other steps in the hiring process in order to get the most out of the interview process. What Are Some of the Potential Problems That Occur When Sales Soar? You hire people who are not properly screened and trained. Or maybe the employees that you've had in the past, just aren't cutout for the "new" business, and they NEED TO BE REPLACED! • Few supervisors and managers savor the idea of being good at firing people. Nevertheless, you need to know how to terminate employees in a way that preserves their dignity while meeting your organization’s needs. Even the most experienced managers will experience stress and anxiety when they go through the termination process. Having a clear idea of the process won’t make it any more pleasant, but could prevent you from making costly mistakes. The Importance of Cash Management Definitions first: • WHAT IS CASH? Cash is ready money in the bank or in the business. It is not inventory, it is not accounts receivable (what you are owed), and it is not property. These might be converted to cash at some point in time, but it takes cash on hand or in the bank to pay suppliers, to pay the rent, and to meet the payroll. Profit growth does not necessarily mean more cash! • A lesson that all entrepreneurs learn is the difference between profit and cash. Profit is the amount of money you expect to make if all customers paid on time and if your expenses were spread out evenly over the time period being measured. However, it is not your day-to-day reality. Cash is what you must have to keep the doors of your business open, while you are busy trying to make a profit. Over time, a company's profits are of little value if they are not accompanied by positive net cash flow. You can't spend profit; you can only spend cash. What Kind of Cash Flow is Good? • POSITIVE CASH FLOW If the cash coming "in" to the business is more than the cash going "out" of the business, the company has a positive cash flow. A positive cash flow is very good and the only worry here is what to do with the excess cash. Like good health, a positive cash flow is something you're most aware of if you don't have it. • NEGATIVE CASH FLOW If the cash going "out" of the business is more than the cash coming "in" to the business, the company has a negative cash flow. A negative cash flow can be caused by a number of reasons. For example: too much or obsolete inventory or poor collections on your accounts receivable (what your customers owe you) can cause you to be short of cash. If the company can't borrow additional cash at this point, the company may be in serious trouble. How To Manage? Cash flow projections Time horizon Short-term (weekly, monthly) Purpose - How used o o o Long-term - Annual (12 months) o To show how much cash will be needed to run the business in the coming year. To determine where the cash will come from. To determine seasonal variations in cash flow. To estimate annual borrowing requirements, ability to make repayments. Supporting information for loan application. o o o o To support strategic planning. To determine equity needs. To estimate borrowing requirements. Supporting information for raising equity capital. o o o o Long-term - Strategic (3-5 years) To determine short-term cash position. To plan amount of cash that can be put in short-term investment account (money market). To estimate working capital requirements. The Importance of Cash Management There are many techniques available for helping you to improve your cash flow. Some of these techniques are: 1. Sell for cash or credit card rather than on terms if your industry practices permit. 2. If you do sell on terms, establish good credit policies 3. Bill promptly and before customer check-writing cut-off. 4. "Age" accounts receivable monthly. 5. Use aggressive collection techniques. 6. Add late charges and fees when possible. 7. Tighten customer credit requirements. 8. Pay bills only on due date (or later if possible) unless there is a discount for early payment. 9. Regulate payments to your suppliers to your advantage (spread out during the month). 10. Reduce your inventory to the most necessary items. 11. Dump slow moving items at cost. 12. Lease instead of purchase equipment. 13. Pay no more estimated taxes than necessary. 14. Make bank deposits promptly. Never leave customers' checks in a desk drawer. Not only will you be losing potential interest, it might even be unsafe. 15. Work your cash. Put excess balances into interest bearing accounts whenever feasible (consider your short-term cash needs). 16. Purchase equipment, supplies, and inventory wisely. 17. Use tax losses or credits. 18. Consider prudent borrowing. 19. Increase sales. 20. Increase prices. The Negative and Positive Benefits of Leverage • Leverage is an important concept to understand as an entrepreneur. Leverage allows you to expand beyond the limits of your own resources by using the resources of others. It is usually used in talking about capital (using your collateral as assets to "leverage" capital from other sources). • Eventually, it becomes impossible to operate your business out of your own personal resources. You must seek outside capital and borrow money to finance growth. If you are already practicing GOOD CASH MANAGEMENT TECHNIQUE and have POSITIVE CASH FLOW, your chances of obtaining outside capital are greatly improved. • However, you should be careful to not get too highly leveraged. That occurs when your level of debt service exceeds cash flow. It is why bankers and investors are so concerned with the debt to equity ratios of a business. The Benefits of Different Capital Sources. Understanding Money Sources • Never enough money! How many times have you said that? You need capital to get sales, buy inventory, pay your employees, purchase assets, pay taxes, you name it - you need money for it. • Your need for capital is a continuing one. Expansion opportunities or a chance to purchase cost-saving equipment can also create a need for extra capital. • To just stay in business or to expand, the small business owner needs capital, but where do you get it? How the Need for Capital Arises? As your business grows, so does your need for more and more capital. Remember there is more than one way and more than one place to raise the money you need. You need to understand the reasons that additional capital is needed -this will play an important role in choosing the right form of additional capital for your business. There are many factors that can create a need for additional capital. Some of the more common are as follows: • Sales growth requires inventories to be built to support the higher sales level. • Sales growth creates a larger volume of accounts receivable. • Growth requires the business to carry larger cash balances in order to meet its current obligations to employees, trade creditors, and others. • Expansion opportunities such as a decision to open a new branch, add a new product, or increase capacity. • Cost savings opportunities such as equipment purchases that will lower production costs or reduce operating expenses. How the Need for Capital Arises? • Opportunities to realize substantial savings by taking advantage of quantity discounts on purchases that will lower production costs or reduce operating expenses. • Opportunities to realize substantial savings by taking advantage of quantity discounts on purchases for inventory, or building inventories prior to a supplier's price increase. • Seasonal factors, where inventories must be built before the selling season begins and receivables may not be collected until 30 to 60 days after the selling season ends. • Current repayment of obligations or debts may require more cash than is immediately available. • Local or national economic conditions which cause sales and profit to decline temporarily. • Economic difficulties of customers that can cause them to pay more slowly than expected. • Failure to retain sufficient earnings in the business. • Inattention to asset management may have allowed inventories or accounts receivable to get out of hand. Combination • Frequently, the cause cannot be entirely attributed to any one of these factors, but results from a combination. • For example, a growing, apparently successful business may find that it does not have sufficient cash on hand to meet a current debt installment or to expand to a new location because customers have been slow in paying. Short- and Long-Term Capital • SHORT-TERM FINANCING is most common for assets that turn over quickly such as accounts receivable or inventories. Seasonal businesses that must build inventories in anticipation of selling requirements and will not collect receivables until after the selling season often need short-term financing for the interim. Contractors with substantial work-inprocess inventories often need short-term financing until payment is received. Wholesalers and manufacturers with a major portion of their assets tied up in inventories and/or receivables also require short-term financing in anticipation of payments from customers. • LONG-TERM FINANCING is more often associated with the need for fixed assets such as property, manufacturing plants, and equipment where the assets will be used in the business for several years. It is also a practical alternative in many situations where short-term financing requirements recur on a regular basis. Available Sources of Capital In order to secure the capital they need, small business owners must understand the various sources of money that are available to them such as the following: • • • • Capital generated internally Capital available from trade creditors Borrowed money Sale of an ownership interest in the business to equity investors. Each of these capital sources has unique characteristics. These characteristics must be fully understood by the small business owner so that he or she will know what sources are available and which source is best suited to the needs of the business. Internal Sources of Capital There are three principal sources of internal capital: 1. Increasing the amount of earnings kept in the business. 2. Prudent asset management. 3. Cost control. Increased Earnings Retention • Many businesses are able to meet all of their capital needs through earnings retention. Each year, shareholders' dividends or partners' draws are restricted so that the largest reasonable share of earnings is retained in the business to finance its growth. • As with other internal capital sources, earnings retention not only reduces any external capital requirement, but also affects the business' ability to secure external capital. Lenders are particularly concerned with the rate of earnings retention. The ability to repay debt obligations normally depends upon the amount of cash generated through operations. If this cash is used excessively to pay dividends or to permit withdrawals by investors, the company's ability to meet its debt obligations will be threatened. Asset Management • Many businesses have non-productive assets that can be liquidated (sold or collected) to provide capital for short-term needs. A vigorous campaign of collecting outstanding receivables, with particular emphasis on amounts long outstanding, can often produce significant amounts of capital. • Similarly, inventories can be analyzed and those goods with relatively slow sales activity or with little hope for future fast movement can be liquidated. The liquidation can occur through sales to customers or through sales to wholesale outlets, as required. Fixed assets can be sold to free cash immediately! Cost Reduction • Careful analysis of costs, both before and after the fact, can improve profitability and therefore the amount of earnings available for retention. At the same time, cost control minimizes the need for cash to meet obligations to trade creditors and others. • Before the fact, a business can establish buying controls that require a written purchase order and competitive bids on all purchases above a specified amount. Decisions to hire extra personnel, lease additional space, or incur other additional costs can be reviewed closely before commitments are made. • After the fact, management should review all actual costs carefully. Expenses can be compared with objectives, experience in previous periods, or with other companies in the industry. Whenever an apparent excess is identified, the cause of the excess should be closely explored and corrective action taken to prevent its recurrence. Equity Capital and Share of Ownership • Unlike debt, equity capital is permanently invested in the business. The business has no legal obligation for repayment of the amount invested or for payment of interest for the use of the funds. • The equity investor shares in the ownership of the business and is entitled to participate in any distribution of earnings through dividends, in the case of corporations or drawings in the case of partnerships. • The extent of the equity investor's participation in the distribution of earnings of a corporation depends upon the number of shares held. In a partnership, the equity investor's participation will depend upon the ownership percentage specified in the partnership agreement. What Type of Capital Does Your Business Need? What does your business need? - Equity, debt or alternative financing? • Too often business owners look for financing in the wrong place! • So, where is the “RIGHT PLACE?” Back to Basics… • • When an individual or an institution "invests" in your company, they are making a capital contribution to your business. In return, they own and have control over some portion of the business and will get repaid through profit sharing or when the company is sold. What next? The business has to have the following characteristics in order to be attractive to investors: 1. High profit margins to provide attractive profitsharing income (dividends) to the investors. 2. Product or service must have significant market appeal and show the potential for rapid future expansion. 3. Potential for a significant return on investment through an “EXIT STRATEGY" such as "going public" or acquisition by a larger corporation. What are Investors Looking for? 1. Better returns than they could get on a portfolio of blue chip stocks but less than professional venture capitalists look for. 2. In addition to financial gain, they also look for "psychic income." Based on their background, many investors want to contribute their expertise as well. 3. Investors are looking for good management and industry potential. What deal do I Offer Them? • When most people are faced with asking friends and family and other private investors for capital, they have very little knowledge on how to approach the deal to make it favorable for both the entrepreneur and the investor. With investor financing as opposed to conventional financing, you can be creative and flexible for the needs of the business. For example: • • You could structure an agreement that has both debt and equity elements. Offer to repay the principal of the investment like a loan over a certain period of time. Because the investor has offered to risk his/her capital on your business, it is often required that you provide a "kicker" as well. This "kicker" could be a percentage of profits for several years. In the first year or so there may be no profits and therefore no "kicker". However in the ensuing years the investor may reap extra income as your business becomes profitable. Many people want to structure an agreement with an investor so that there is a timely exit for that investor. Many people do not want an investor involved in their business forever, but want to ensure they are paid off and out of the business in a reasonable period of time. Likewise investors want to know when they can reap their investment. Be sure and consult with an attorney and get her to help you make all the necessary disclosures, etc. -- even though you are working with a private offering it requires careful analysis and legal agreements. Some Hints and Tips… Here's some suggestions for communicating with potential investors: • 1. Have a carefully designed business plan with a two or • three page investor prospectus. • 2. • • • • Investor prospectus should include: how return on investment will be calculated and distributed guarantees (if any) to reduce risk exit requirements for the investor length of time for the terms of the prospectus Conclusions • • • • • • • • Plan professionally Aim for transparency Aim for solid corporate governance practices Seek assistant whenever you need it! Realize your own skills and lack of them as well! Don’t look instant gratification – rewards will be there! Hire when needed, fire when needed! Underpromise and overdeliver! Thank You! 33