This article is the first of a two-part series. Read Part 2 here.
Growth is expensive for any business. We discussed it in our article about EBITDA. You can get a better understanding of the expense of growth in this HBR article.
This creates a delicate balance between growth and cash that needs to be maintained for a growing business. As you try to grow fast, you’ll find yourself cash-poor.
This article helps owners of fast-growing tech services businesses to understand the balance. In the second part of this series we will discuss the consequences of going out of balance and building a strategy resilient to going out of balance.
Cost Of Growth for a Services Company
The HBR article talks about the Operating Cash Cycle (OCC) and it talks about the time for creating the product, putting it in inventory, and then the sale of the product. At first glance, this language makes it seem like the rules for services are different. The key is in recognizing the services rendered as the goods sold.
When you hire an engineer, there is a delay caused by searching for & recruiting the right talent and then ramping them up to your team's needs. Once deployed, they bring in revenue but there is another delay defined by the net terms with your customer before you finally see cash inflow. This complete cycle can get very expensive before the engineer starts to bring in money.
In addition, there are similar constraints on the cost of sales. Services businesses usually have longer and more people-intensive sales cycles. That means increased investment in marketing channels and partnerships, bringing up account managers, and waiting three months for them to mature in their roles.
Additionally, in early-stage organizations, as many as two-thirds of the account managers don’t fit so you need to hire three times more than needed to hit growth targets. So growing the sales pipeline quickly is also extremely expensive.
Hitting the Bullseye: The Ideal Balance
All of these costs come together to make growth extremely cash-intensive and create a balance that the company must maintain between spending cash and attainable growth. It is important to recognize that maintaining this balance poses an existential threat to your company and to your mental health. So let’s talk about how to hit the bulls-eye.
Measured Growth
The truth is high growth is extremely profitable. Let’s take a fast-growing company that makes 500k. Assume a great net margin of 20% that translates into 100k in cash. On the flip side, with an exit multiple between 3-5x that 500k is adding 1.5M to 2.5M to the net worth of the owners of the company. Growth is extremely lucrative to the owners of the business and your incentives are aligned to making it happen.
Putting extra cash back into the business to grow faster is also very profitable to the owners — even necessary to get the financial outcomes that they are looking for. And owners should be trying to grow fast.
But it is important to remember that the higher growth you target, the more cash you will expend and the smaller your margin of error. So the best thing you can do to hit the bullseye is to put thought into what sustainable growth looks like.
Reducing Operating Cash Cycle
The Operating Cash Cycle was bound by your ability to get the right people in place both in sales and delivery. In our article How To Quickly Scale Your Tech Services Company we discuss how to reduce the ramp-up time for team members.
It's also helpful to keep in mind that good contractor relationships can increase your supply of on-demand capacity. You also need to be cognizant of the net payment terms your customers are asking for and use it as a lever during negotiations.
Improving Forecasting
Leave fewer things to chance by implementing good planning and forecasting. We've already covered the basic metrics you need to get a handle on your sales forecasting. In addition, develop lines of business with long-term and recurring revenue to get off the treadmill and more certainty in your forecasting. Up to 80% of the revenue of service companies comes from repeat customers.
Be More Profitable
There is also the obvious solution to increase profitability. Reduce your COGS and increase your prices. You should always be focused on this while also being mindful of the value you deliver to the customer as you work on your cost and prices. This is work you need to be doing anyway.
Wrapping Up
Growth costs cash. You can be an extremely profitable and fast-growing company but can still go bankrupt because you don't have the cash to pay your expenses and all of your money is locked in future payments.
This article taught you how to manage the balance of growth and cash, which translates into balancing sales and hiring. In our next article in the series we will explore the risks going out of balance poses to your company so you can better grasp the consequences of strategic decisions you make regarding the desired growth of your company.
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