20080312 Bq Sustainable Growth

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Licensed under Creative Commons license by Business Quests. www.businessquests.co m What growth level can your business sustain? Understanding business growth & adopting ways to manage more of it better

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This is a quick overview of key concepts of business growth sustainability. It explains how the financial structure of the business affects growth and shows options for better managing business growth.

Transcript of 20080312 Bq Sustainable Growth

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What growth level can your business sustain?

Understanding business growth & adopting ways to manage more of it better

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What you need to know1

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Case study: the QuestCo corporation

Conclusions

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About sustainable growth…

Why is the assessment of sustainable growth relevant?

What is sustainable growth today?

How does the financial structure affect sustainable growth?

What if you proactively managed resources for growth?

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Why you should assess your maximum sustainable business growth

Elementary management foresight & planning

Fundamental to define your financial policy

Critical to the allocation of financial and non-financial resources

Fundamental to adequately set expectations of personnel and key partners = credibility of management

Helps you discuss financial solutions well ahead of the time when you may need them for the business Credibility with your financial partners

Better ability to negotiate terms

Your financial structure sets the limits of your investments in future business growth

Failing to optimize the use of your resources means you will loose investment opportunities, place unnecessary financial strain on your business and put jobs in danger

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What is sustainable growth today?

Sustainable growth is defined by limitations in Financial resources Access to talent both internal and external The ability to attract customers The effectiveness of the network of key suppliers The competitive responsiveness of the business The use of natural resources, esp. in context of growing pressures to

tax use of scarce environmental resources

Sustainable growth is far more than the result of elaborate financial calculations, yet quantitative limits are key

Sustainable growth means growth that strengthens the business and the system to which the business belongs, including the environment, suppliers, employees, local communities…

Focus of this material is on the financial assessment of sustainable business growth

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The financial structure of your business affects sustainable growth in a major way

The financial structure & cycle of your business affects maximum sustainable business growth Money tied in your inventory Money tied in the commercial cycle as accounts receivable Available cash (pure liquidity of business operations) Implicit credit by suppliers as accounts payable

Some investments are compulsory & absorb financial resources Maintenance of machines and software costs money Replacement of productive equipments to continue operations

Discretionary investments only after the existing financial cycle and compulsory investments are funded Discretionary investments are usually based on a specific business

case and on the corporate investment policies How will growth affect existing business activities? How reliant is your future growth on (limited) natural resources?

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Structure of balance sheet and sustainable growth: the most quantitative assessment

Tangible assets

Assets = uses Liabilities = resources

Intangible assets

Inventory

Cash

Accounts receivable

Equity

Long term debt

Retained profits

Short term debt(arising from operations)

Accounts payable

Working capital

Net working capital

Increase of net working capital absorbs financial resources

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Structure of balance sheet and sustainable growth: the most quantitative assessment

Working capital

Increase of net working capital absorbs financial resources

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Fixed assets = committed to long term

use by the business

Assets = uses Liabilities = resources

Current assets of business operations

= working capital

Long term financial resources

Net working capital

Current liabilities(arising “spontaneously”

from operations)

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Net working capital

Funding requirements stemming directly from the growth of existing operations

Growth increase of current assets need to fund growth of net working capital

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Fixed assets = committed to long term

use by the business

Assets = uses Liabilities = resources

Current assets of business operations

= working capital

Long term financial resources

Working capital Current liabilities

(arising “spontaneously” from operations)

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Biggest managerial impact is through allocation of resources: priorities matter a great deal!

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Liquidity at start of FY

Labor

Materials

General expenses

Maintenance & replacements

Discretionary investments

Inventory

Accounts receivable

Liquidity at end of FY

Retained earnings

Taxes InterestsEquity returns

New resources

New capital

New debt

Resources

Uses

Key

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What can you do to proactively manage resources for growth?

Manage and optimize your net working capital: Offer payment terms to customers in accordance with their strategic

importance to your business Make sure customers pay on the agreed terms Negotiate the best possible payment terms with suppliers Keep inventory under control

Optimize your cost structure Keep fixed costs under control as they affect break-even and use of

cash Negotiate service level and cost with key suppliers

Prioritize investments Compulsory before discretionary Discretionary investments with best expected return first

Negotiate with financial partners to be assured to fund all growth opportunities adequately

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What you need to know1

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Case study: the QuestCo corporation

Conclusions

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Introduction to the QuestCo case study

QuestCo is a software development company that markets own software products and offers IT development services

Totally self-financed

High-growth resulting largely from exceptional commitment of founders and early joiners

Weak management of net working capital and “intuitive” allocation of financial resources

Key questions to assess: how much can the business grow given its financial structure?

what are the options of management to enhance sustainable growth?

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QuestCo’s Financials & Sustainable Growth

QuestCo's Operating Cash Cycle

Duration Cash is Tied Up (days)Accounts receivable 95 daysInventory 68 daysOperating Cash Cycle (OCC) 164 daysAccounts payable 41 daysCost of sales 123 daysOperating expenses 82 daysIncome statement (EUR)Sales 1.000€ Cost of sales 0.615€ Operating expenses 0.308€ Total costs 0.923€ Profit (cash) 0.077€ Amount of Cash Tied Up per Sales Dollar (EUR)Cost of sales 0.461€ Operations 0.154€ Cash required for each OCC 0.615€ Cash Generated per Sales Dollar 0.077€

QuestCo's Financial Statements

INCOME STATEMENT (IN '000) EUR % of salesSales 13,000 100.0%Cost of sales 8,000 61.5%Gross Profit 5,000 38.5%Operating expenses 4,000 30.8%Taxes 30.0% 300 2.3%Net profit after tax 700 5.4%

BALANCE SHEETCash 300 Accounts receivable 3,400 Inventory 1,500 Total current assets 5,200 Infrastructure & equipment 700 Total assets 5,900

Accounts payable 900 Bank loan payable 1,500 Total current liabilities 2,400 Contributed capital 150 Retained earnings 3,300 Total owner's equity 3,450 Total equities 5,850

Number of Operating Cash Cycles = 365 / OCC = 2.23

SG per OCC = Cash generated per sales dollar / Cash required per OCC = 12.51%

Sustainable year on year growth = 27.8%

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Option 1: Speeding Cash Flow

QuestCo's Operating Cash Cycle

Duration Cash is Tied Up (days)Accounts receivable 90 daysInventory 64 daysOperating Cash Cycle (OCC) 154 daysAccounts payable 41 daysCost of sales 113 daysOperating expenses 77 daysIncome statement (EUR)Sales 1.000€ Cost of sales 0.615€ Operating expenses 0.308€ Total costs 0.923€ Profit (cash) 0.077€ Amount of Cash Tied Up per Sales Dollar (EUR)Cost of sales 0.451€ Operations 0.154€ Cash required for each OCC 0.605€ Cash Generated per Sales Dollar 0.077€

QuestCo's Financial Statements Option 1: Speeding Cash Flow

INCOME STATEMENT (IN '000) EUR % of salesSales 13,000 100.0%Cost of sales 8,000 61.5%Gross Profit 5,000 38.5%Operating expenses 4,000 30.8%Taxes 30.0% 300 2.3%Net profit after tax 700 5.4%

BALANCE SHEETCash 300 Accounts receivable 3,200 Inventory 1,400 Total current assets 4,900 Infrastructure & equipment 700 Total assets 5,600

Accounts payable 900 Bank loan payable 1,500 Total current liabilities 2,400 Contributed capital 150 Retained earnings 3,300 Total owner's equity 3,450 Total equities 5,850

A 5.8% drop of current assets… …causes an 8% drop in days of cash tied up…

… and an increase of sustainable growth to 30.2% up from 27.8%, i.e. an improvement of almost 8.5%

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QuestCo's Operating Cash Cycle

Duration Cash is Tied Up (days)Accounts receivable 95 daysInventory 68 daysOperating Cash Cycle (OCC) 164 daysAccounts payable 41 daysCost of sales 123 daysOperating expenses 82 daysIncome statement (EUR)Sales 1.000€ Cost of sales 0.604€ Operating expenses 0.305€ Total costs 0.908€ Profit (cash) 0.092€ Amount of Cash Tied Up per Sales Dollar (EUR)Cost of sales 0.452€ Operations 0.152€ Cash required for each OCC 0.605€ Cash Generated per Sales Dollar 0.092€

QuestCo's Financial Statements Option 2: Reducing Costs

INCOME STATEMENT (IN '000) EUR % of salesSales 13,000 100.0%Cost of sales 7,850 60.4%Gross Profit 5,150 39.6%Operating expenses 3,960 30.5%Taxes 30.0% 357 2.7%Net profit after tax 833 6.4%

BALANCE SHEETCash 300 Accounts receivable 3,400 Inventory 1,472 Total current assets 5,172 Infrastructure & equipment 700 Total assets 5,872

Accounts payable 884 Bank loan payable 1,500 Total current liabilities 2,384 Contributed capital 150 Retained earnings 3,300 Total owner's equity 3,450 Total equities 5,834

Option 2: Reducing Costs

Reducing cost of sales by 1.9% and operating expenses by 1.5%… …dramatically improves cash generation…

… which pushes sustainable growth to 33.7% up from 27.8%, i.e. an improvement of over 20%

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QuestCo's Operating Cash Cycle

Duration Cash is Tied Up (days)Accounts receivable 95 daysInventory 69 daysOperating Cash Cycle (OCC) 165 daysAccounts payable 42 daysCost of sales 123 daysOperating expenses 82 daysIncome statement (EUR)Sales 1.015€ Cost of sales 0.615€ Operating expenses 0.308€ Total costs 0.923€ Profit (cash) 0.092€ Amount of Cash Tied Up per Sales Dollar (EUR)Cost of sales 0.460€ Operations 0.154€ Cash required for each OCC 0.614€ Cash Generated per Sales Dollar 0.092€

QuestCo's Financial Statements Option 3: Raising Prices

INCOME STATEMENT (IN '000) EUR % of salesSales 13,000 100.0%Cost of sales 7,882 60.6%Gross Profit 5,118 39.4%Operating expenses 3,941 30.3%Taxes 30.0% 353 2.7%Net profit after tax 824 6.3%

BALANCE SHEETCash 300 Accounts receivable 3,400 Inventory 1,500 Total current assets 5,200 Infrastructure & equipment 700 Total assets 5,900

Accounts payable 900 Bank loan payable 1,500 Total current liabilities 2,400 Contributed capital 150 Retained earnings 3,300 Total owner's equity 3,450 Total equities 5,850

Option 3: Raising prices

Raising prices by a mere 1.5%… …dramatically improves cash generation…

… which pushes sustainable growth to 33.1% up from 27.8%, i.e. an improvement of 19%

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QuestCo's Operating Cash Cycle

Duration Cash is Tied Up (days)Accounts receivable 90 daysInventory 65 daysOperating Cash Cycle (OCC) 155 daysAccounts payable 41 daysCost of sales 114 daysOperating expenses 77 daysIncome statement (EUR)Sales 1.015€ Cost of sales 0.613€ Operating expenses 0.309€ Total costs 0.922€ Profit (cash) 0.093€ Amount of Cash Tied Up per Sales Dollar (EUR)Cost of sales 0.450€ Operations 0.155€ Cash required for each OCC 0.605€ Cash Generated per Sales Dollar 0.093€

QuestCo's Financial Statements Pulling multiple levers

INCOME STATEMENT (IN '000) EUR % of salesSales 13,000 100.0%Cost of sales 7,850 60.4%Gross Profit 5,150 39.6%Operating expenses 3,960 30.5%Taxes 30.0% 357 2.7%Net profit after tax 833 6.4%

BALANCE SHEETCash 300 Accounts receivable 3,200 Inventory 1,400 Total current assets 4,900 Infrastructure & equipment 700 Total assets 5,600

Accounts payable 884 Bank loan payable 1,500 Total current liabilities 2,384 Contributed capital 150 Retained earnings 3,300 Total owner's equity 3,450 Total equities 5,834

What if all options were combined?

Improved cost efficiency, higher prices and reduced current assets… …dramatically improve cash usage

& generation…

… which pushes sustainable growth to 36.2% up from 27.8%, i.e. an improvement of almost 30%

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What you need to know1

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Case study: the QuestCo corporation

Conclusions

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Key lessons to take away

Optimal management of available financial & business resources can give your business an extra boost

Managing your cost structure tightly is essential and will also affect your break-even point

Measuring key aspects of financial structure helps you identify options for achieving more with existing assets

Options to consider depend on your position in the market Negotiating position vis-à-vis suppliers

Negotiating position vis-à-vis customer

Intensity of competition

The differentiation of your business relative to competitors

Price sensitivity of your customers

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Bibliography

Janet Kiholm Smith and Richard L. Smith, Entrepreneurial Finance, 2004, John Wiley & Sons

Neil C. Churchill and John W. Mullins, How Fast Can Your Company Afford to Grow?, May 2001, Harvard Business Review, vol. 79, no. 5

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