Executive Insight #022 Growth Is a Decision Before It’s a Number

Why the Financial Commitments of Growth Often Begin Before the Revenue Arrives

Estimated Reading Time: 8 Minutes

Key Insight: Growth eventually appears as a number on the income statement, but it begins much earlier as a series of management decisions. Inventory, people, capacity, customer terms, equipment, and working capital may all be committed before the additional revenue becomes cash. Understanding those commitments is essential to understanding what growth will require from the business.

Executive Observation

Growth is usually discussed as an outcome.

Revenue increased 12 percent. Unit volume grew 18 percent. The company added 40 new customers. A new market produced $3 million in sales. A major account doubled in size.

Those are useful measures because they tell management what happened.

But by the time growth appears in the financial statements, many of the most important decisions have already been made.

Someone decided to pursue the customer. Someone quoted the price. Purchasing ordered additional inventory. Production committed capacity. People were hired or overtime was authorized. Customer terms were negotiated. Equipment may have been purchased. Warehouse space may have been expanded. Additional borrowing may have been arranged.

The revenue number comes later.

That is why growth should not be viewed simply as a financial result.

Growth is a decision before it becomes a number.

Revenue Is the Visible Part of Growth

When companies establish growth objectives, the target is usually expressed in revenue.

Grow 10 percent.

Reach $25 million.

Add $5 million in new business.

Double the company in five years.

There is nothing wrong with those objectives, but revenue represents only the visible outcome. The business has to build the operating structure required to produce and support that revenue.

For a product business, that can mean additional raw materials, finished goods, labor, production time, warehouse capacity, freight, receivables, equipment, and management resources.

Those requirements do not necessarily arrive after the sale.

Many arrive before it.

A manufacturer expecting substantial additional demand may have to order raw materials months in advance. A distributor may need inventory on the shelf before the customer places the first meaningful order. A company entering a new market may need salespeople, systems, or warehouse capacity before the market produces enough revenue to cover those costs.

Growth therefore creates a timing issue before it creates a revenue number.

Management commits resources based on what it expects the business to become.

The Customer Can Be Profitable and Still Require Cash

Consider a manufacturer that wins a major new customer.

The economics look attractive. The pricing produces an acceptable margin. The customer is financially strong. Management believes the relationship could continue for years.

It sounds like exactly the kind of customer the company should want.

But now the business has to perform.

Raw materials must be purchased. Inventory may need to increase. Production schedules have to accommodate the additional volume. Employees may work overtime or new people may need to be hired. Freight expense increases. Additional tooling or equipment may be required.

Then the company ships the product and creates a receivable.

If the customer pays in 45 or 60 days, the company may have funded much of the operating cycle long before it receives the cash.

The customer can therefore be profitable and still create significant financial pressure during the growth period.

There is no contradiction.

Profitability answers one question.

Cash requirements answer another.

Management needs to understand both.

Growth Creates Commitments Before It Creates Cash

This is one of the characteristics of growth that can surprise otherwise successful businesses.

The company sees the opportunity first.

The financial commitment follows.

The cash return may come later.

Suppose a distributor expects sales to increase substantially over the next year. Management may increase inventory to support the anticipated volume. Additional warehouse employees may be hired. Salespeople may be added. Delivery capacity may be expanded. Software or systems may need to be upgraded.

The company has now increased its financial commitments based on future expectations.

If growth develops as planned, those investments may prove entirely justified.

If growth arrives more slowly than expected, the commitments don't automatically disappear.

Employees still receive paychecks. Inventory still occupies the warehouse. Equipment payments still come due. Leases continue. Software contracts remain. Debt still requires servicing.

This is why the growth decision involves more than estimating the additional revenue and profit.

Management also needs to understand what must be committed before the expected result arrives.

Working Capital Often Moves First

For many product businesses, working capital is where the financial requirements of growth become particularly visible.

Imagine a company increasing sales by $5 million.

If customers buy on credit, the company will probably carry additional receivables. If more products must be available to support the additional sales, inventory may increase. Accounts payable may provide some financing depending on supplier terms, but it may not finance the entire increase.

The remaining requirement has to come from somewhere.

Cash generated by the business.

Existing cash reserves.

A line of credit.

Additional debt.

Owner capital.

Or some combination of them.

This is why a company can report strong sales growth and improved profit while simultaneously experiencing greater pressure on cash.

The income statement records the additional revenue and profit.

The balance sheet shows where some of the cash has gone.

Growth has created a larger business, but the larger business may require more capital to operate.

Capacity Decisions Can Arrive Even Earlier

Working capital isn't the only financial commitment associated with growth.

At some point, growth can require capacity.

A manufacturer may need another production line. A distributor may need additional warehouse space. A company may need more trucks, technology, management infrastructure, or specialized employees.

These decisions can be particularly challenging because capacity often has to be added in increments.

A company cannot always buy exactly 12 percent more warehouse space because sales are expected to grow 12 percent. It may have to lease an entire additional building.

A production line may create substantially more capacity than the company needs immediately.

A senior manager represents a full position even if the organization initially requires only part of that person's capacity.

Management can therefore face a period when the cost structure moves ahead of revenue.

That does not necessarily mean the investment was wrong.

It means growth sometimes requires the business to build tomorrow's capacity with today's cash.

Growth Decisions Extend Across the Business

One reason growth deserves careful management attention is that it rarely belongs to one department.

Sales may identify the opportunity, but Operations has to deliver it. Purchasing has to support it. Finance may have to fund it. Human Resources may have to staff it. Warehousing may have to store it. Customer service may have to support it. Leadership may have to manage the additional complexity.

A growth decision made primarily from a sales perspective can therefore create consequences throughout the organization.

This is not an argument against growth.

It is an argument for seeing the whole decision.

A large new customer may be an excellent opportunity even if it requires additional inventory and receivables. A new market may justify additional people and capacity. A product launch may require substantial investment before it produces meaningful revenue.

But management should understand those requirements when evaluating the opportunity—not discover them gradually after the growth has already been committed.

Not All Growth Has the Same Cash Requirement

Two companies can each grow revenue by 20 percent and experience very different financial consequences.

One may have excess production capacity, low inventory requirements, customers who pay quickly, and suppliers providing favorable terms. Much of the additional gross profit may convert relatively quickly into cash.

Another may need substantial inventory, extended customer terms, additional employees, new equipment, and more warehouse space. Its 20 percent growth may require a significant amount of additional capital.

The growth rate is identical.

The financial requirements are not.

Even within the same company, two growth opportunities can have very different cash characteristics. One customer may require little additional inventory and pay in 20 days. Another may require specialized inventory, dedicated equipment, and 60-day payment terms.

Looking only at expected revenue can make those opportunities appear more similar than they actually are.

The question isn't merely:

How much can this opportunity increase sales?

Management also needs to ask:

What will this growth require from the business before the cash arrives?

Growing Broke™ Is Not About Avoiding Growth

I've used the phrase Growing Broke™ for years because it captures a situation many owners initially find difficult to reconcile: the company is growing, the income statement looks healthy, and yet cash becomes increasingly constrained.

The phrase is not an argument that growth is dangerous or that businesses should protect cash by refusing attractive opportunities.

Growth is essential for many companies. It can create scale, improve competitive position, develop people, increase enterprise value, and create opportunities that would not otherwise exist.

The issue is whether the business can financially support the growth it chooses to pursue.

Profitable growth can still consume cash. Rapid growth can consume it faster. And if management does not understand the working-capital and capacity requirements in advance, a successful growth strategy can create a financial problem precisely because the business is succeeding.

The objective isn't less growth.

It is financially sustainable growth.

Growth Is Really a Series of Decisions

There is another reason I describe growth as a decision before it becomes a number.

Management doesn't actually make one decision called “growth.”

It makes many decisions that collectively create growth.

Which customers should we pursue?

What price should we quote?

What payment terms should we accept?

How much inventory should we carry?

Do we have enough capacity?

Should we hire before the volume arrives?

Should we purchase equipment now or wait?

How much additional working capital will be required?

How will we finance it?

How quickly should we grow?

Those are the actual decisions.

Revenue growth is what eventually appears when many of them work together.

This is consistent with the larger idea behind the Decision Problem: financial results are downstream from management decisions. Growth is simply one of the clearest places to see the relationship.

Executive Reflection

Think about the most significant growth opportunity currently facing your business.

Don't begin with the expected revenue.

Begin with what has to happen before the revenue becomes cash.

What inventory will be required? Will receivables increase? What payment terms will customers expect? Will additional employees be needed? Is existing capacity sufficient?

Will equipment or warehouse space be required? What operating expenses will increase? When will those commitments occur? When should the cash from the growth begin returning to the business?

Then ask the question that connects all of them:

How much financial capacity will this growth require before it begins strengthening our cash position?

The purpose is not to build a perfect forecast. Business rarely provides that level of certainty.

The purpose is to make the financial requirements of growth visible while management still has choices about how to structure the opportunity.

The BusinessWiser™ Perspective

Growth is one of the ten Cash Flow Drivers in Most SMBs Don't Have a Cash Flow Problem™ — They Have a Decision Problem because growth can influence several other drivers simultaneously.

Additional sales can affect pricing, cost of goods sold, operating expenses, inventory, receivables, accounts payable, capital expenditures, and debt. The growth decision therefore cannot always be understood by looking at revenue alone.

That is also why the BusinessWiser™ approach does not classify cash-consuming growth as inherently bad. Businesses invest resources to create future economic value. Some attractive opportunities require significant cash before their benefits are realized.

The management challenge is visibility.

What are we committing?

When will we commit it?

How much cash will be required?

How long could that cash remain committed?

Where will the funding come from?

And what happens if growth develops differently than expected?

Those questions move growth from an abstract revenue target to a management decision.

They also begin connecting the two sides of the Dynamic Duo.

The decisions management makes determine how the business uses and generates cash.

And the financial strength that results helps determine which opportunities the business can pursue next.

Related BusinessWiser™ Resources

Executive Guide: Most SMBs Don't Have a Cash Flow Problem™ — They Have a Decision Problem

Executive Guide: Cash Flow Creates Options™

Executive Tool: One-Page Net Cash Flow Driver Report

Framework: CASHfloWiser™

Framework: DRIVERwiser™

Framework: FORECASTwiser™

Podcast: Executive Insight #022 — Growth Is a Decision Before It's a Number

Final Thought

Growth eventually appears on a financial statement as revenue.

But that is not where growth begins.

It begins when management decides which customers to pursue, what prices to accept, how much inventory to carry, what terms to offer, which people to hire, when to add capacity, how much capital to commit, and how quickly the business should expand.

Those decisions frequently require cash before the additional revenue produces cash.

That doesn't make growth a problem.

It makes growth a financial commitment as well as a business opportunity.

Long before growth becomes a number, it becomes a decision.