Are You Making Enough Profit to Grow?
Chaitanya Sagar
Aug 20, 2009 - I have spoken to many small business owners recently. I wanted to know from them what their plans to grow are. This is what I realized when I talked to them. Each of the business owners thinks her business is a ‘work-in-progress.’ Not a finished product. They believe that they are going to be big – though they are small now.Many have a ‘cash-flow’ view of their business and not a profit approach to it. Let me explain. When I say ‘cash-flow’ approach, they understand how much cash is coming in and how much is going out as expense. But what they don’t know are answers to the following questions:
Did I make a profit or loss?
Am I earning enough to grow?
How am I going to fund growth?
If I continue my current funding strategy, will growth be possible? The scary thing is that some have been in ‘I-will-grow’ mode for over 10 years. And they have either given up their growth plans or are still in the growth illusion. What is Your Strategy to Fund Your Business Growth?I will use two broad categories of funding for this discussion. First is external (I include everything from VC funding to a bank loan in this category) and second is internal accrual. Internal accruals are used by most small businesses to fund growth. Now that we have gotten that out of the way, are your internal accruals sufficient to fund your growth? How will you know?It’s Not Sufficient If You BreakevenWhen someone says they have “broken even” in the business, they generally mean that have been able to pay all bills from revenue. However, when you break even, did you realize that you may actually have an accounting loss in that month? Because to calculate accounting profit or loss, you have to deduct ‘non-cash’ expenditures like depreciation. When you do that, you may actually end up with a net loss. Net Income Determines If You Can Grow I had this question about ‘am I funding my business right’ that had been bugging me for some time. And I modeled it in a simple spreadsheet. What I noticed is startling. But first the assumptions I made.
I assumed the starting revenue is $100. (you can make it $100K if you want)
I have assumed that entire Net Margin is reinvested in the business (in the model you can download, I have given another option – reinvest only 50% in the business).
I have assumed a ‘growth multiplier’ factor which is if you reinvest $100 into the business, it leads to revenue growth of reinvestment times growth factor from next month onwards. ResultsThe results of the modeling are revealing. If you have a 5% net margin, and 10% growth multiplier, it’s difficult to make even 5-6% growth per year. But if you have a 20% net margin and a 30% growth multiplier, you can achieve as much as 80% growth in a year. The crux of this model is that it’s important to know how much net margin you are making. And it’s important to know how much you are reinvesting in ‘growth expenditure’ (i.e. marketing or other expenditure that results in growth in revenue). I have given the financial model itself so you can play with it and generate your own insights. Share your thoughts!
Chaitanya Sagar is the Founder and CEO of p2w2 (for PeopleToWorkWith), which helps small businesses outsource services like business and financial planning, software, virtual assistance, and research. p2w2 focuses on building relationships with vendors so you can focus on your business. Chaitanya blogs at p2w2 blog.
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