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The Five Key Ways Sales Growth Consumes Cash

Updated: Sep 19, 2020

Everyone loves top-line sales growth! It’s exciting, it always provides a story to tell when you need it, and it checks the top box on the Company’s overall health report card. Sales growth is of course necessary to sustain a business in the long run. No one wants to be associated with a business that isn’t growing, or doesn’t have solid prospects for future growth. However, to grow sales, you need to expect and plan for the consumption of cash. It’s the dirty secret – the downside – to growth. So, what do you plan for? There are five key areas I’ve identified where lower middle market businesses should be prepared to “spend in order to grow”, as well as the related approximate time frames for incurring a liquidity shortfall.

1. Hiring / Funding Payroll – Short-Term (0-3 mos.)

In order to grow sales in most industries, you will need to hire additional labor – but I’m thinking especially about construction, services, and manufacturing businesses. In the case of construction, you are typically expanding your crews, and ostensibly, you’ll incur additional costs for hiring, training, uniforms, personal protective equipment, etc. Once that new labor gets out on the job, they are of course billable. However, there will be a definite lag between their first few (or more) paychecks and receiving payment from your customer, particularly if your customer pays on terms. That principle, of needing to pay your employees before your customer pays you, is omnipresent in almost every business. You need to plan for the short-term liquidity required to cover those increases in payroll and hiring costs, prior to your customer payments catching up. And, this is one you don’t want to get wrong. There’s not much worse in business than missing, or being short on, payroll.

2. Inventory – Short-Term/Intermediate (0-12 mos.)

If you manufacture, distribute or retail a product, you of course need inventory for sales. In some businesses, there’s opportunity to drop-ship inventory directly from a supplier to your customer, or to keep the inventory on consignment at the supplier’s facility. Those are often fantastic opportunities that can be a real boon to your cash flow and margins. However, for most, you’ll need to bring that inventory in-house first before you can make the sale. That inventory has to be bought, unloaded, stored, often assembled or processed, and later packaged and shipped. Seek for the best payment terms you can possibly get from your suppliers, but be prepared for a short-term, net cash outlay, or initial negative cash impact, as you grow your inventory.

3. Rental Equipment – Short-Term (0-3 mos.)

This goes hand-in-hand with with growing your payroll or your inventory, but is particularly applicable to construction and service businesses. As you rent more equipment to complete the new jobs powering your growth, you’ll likely need to cover those additional rental payments prior to collecting the associated cash receipts from your customers – another short-term liquidity need.

4. Marketing Expenses – Intermediate (0-18 mos.)

Marketing expenses, if managed unwisely, can become a “black box” of unknown value and consumption of cash. Conversely, if managed wisely, marketing expenses can be the life blood for generating new and more business – your challenge is determining the what, the how, the where, and the when. In all likelihood, you will absorb negative cash flow upfront as you incur and pay for your marketing expenses – even if paying your vendors on terms.

Marketing, particularly Internet marketing, has become much more of a science in the last twenty years or so, demanding fastidious tracking and multiple metrics to evaluate overall effectiveness and ROI. In addition to ROI, understanding the time it takes to gain traction (i.e. the payback period) is huge – does it look like 60 days, six months, a year? You need to forecast based upon the best market information you can obtain to determine that time frame.

5. Capital Expenditures – Long-Term (0-36 mos.)

Like marketing expenses, capital expenditures (“CapEx”) can also become a black box of unrealized value if they are not carefully planned and monitored. Businesses can easily succumb to “shiny new object” syndrome and there are endless ways to spend money – a new building or new office space, the best new truck or piece of machinery, etc. In addition, businesses experiencing significant growth can easily succumb to a mentality of “spend now, plan later.” For a number of reasons, that can be a recipe for disaster.

CapEx planning should be done annually in conjunction with the budget, and should be as specific as possible. Benefits to the business quantified in payback, return on investment (ROI) and net present value (NPV) calculations should drive approval. In addition, the planning should include careful modeling to ensure adequate financing, as well as the right kind of financing. For example, if debt is used, the Company will need to meet the incremental debt-service obligations incurred, as well as stay within the debt facility covenant parameters. It may be better to fund with an equity infusion, or if adequate, from operating cash flow.

As mentioned above, determining the right kind of financing to fund your growth is critical. Too much debt, or leverage, can easily sink the ship, while relying solely on operating cash flow puts significant strain on the business and will likely create a low ceiling for maximizing opportunity. Equity funding has its own considerations, particularly when it comes to dilution effects, control of the business, and seniority ranking, or preference, upon pay out. No matter your financing choice, the key here is to remember that when planning for sales growth, you need to account for the short-term, intermediate, and long-term liquidity needs to fund that growth. Otherwise, you might wake up one day to find that you’ve grown yourself right out of business!

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