An increase in sales sounds great! Right? But have you ever heard about the colloquialism of growing out of business? Growth requires cash flow, but sometimes, quick growth doesn’t allow you to keep up. If a company is run by leaders with sales backgrounds, they will be more focused on the growth than supporting that growth. Sometimes, it’s difficult for a company to sustain growth, especially if they aren’t collecting receivables quickly. This leads to some companies turning away clients. The analysis and forecasting of working capital is crucial in a high growth situation.
What is the J Curve?
A j curve is an initial loss followed by an exponential growth. This curve is used in the medicine, political science, economics, and in business. The quicker you grow, the quicker your burn through cash.
Cash is king, net working capital which is current assets less current liabilities is an indicator of the companies ability to meet short term obligations. In a high growth situation you will burn through net working capital and need to manage it carefully.
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J Curve Effect
Initially, there is a decrease in sales, then there is a sudden growth. This growth ties up cash flow. Inventory requires significant cash to supply the demand. But if the company invoices the customer, then there is a risk of not being paid for 15, 30, or 60 days. Even if the company collects the cash up front, it doesn’t always align with when payments are due.
Let’s look at the Cash Conversion Cycle!
There are three things that impact the cash status for a company: sales, inventory, and payables. In other words, revenue, COGS, and overhead. If one of those are out of balance, then profitability will be impacted. If they are out of balance and net working capital is on a decline, then you are really in trouble. When you experience a j curve effect, you will see all increase in all areas with more emphasis on payables.
When J Curves Are Likely to Happen
There a couple instances where j curves are more likely to happen. Fasting growing firms and startups are two examples where we frequently find j curves in action.
Startups typically begin out of a need seen in a market. At some point, their product/service clicks with the market and they take off. This is great for the start up! But if the company doesn’t have liquidity or cash, then it will not be able to support the growth. In addition, you risk the quality of your product/service, dealing with legal issues associated with poor quality, and having bad reviews. For example, a startup finally hits the market at the right time with the right product. Sales boom and the entrepreneur is ecstatic! But they have no processes, they are buying materials for the product without thinking strategically, and are only looking at the sales. While sales were booming, they were buying everything on the company’s Amex. At the end of the month, the fees and lack of consideration for the timing of purchase outweighed the increase in sales. They ended up in the red.
Fast Growing Firms
Fast growing firms also see the same issues that startups deal with. In addition, fast growing companies tend to grow overhead quickly or lose sight of how big it is actually getting – larger operations, more employees, bigger reputation, etc. For example, $1 Billion fitness company Beachbody released a new fitness program earlier this month. Unfortunately, they did not forecast the sales accurately and were not prepared for the amount of sales they received. What could be a great opportunity turned into a scramble to deliver on the equipment needed for a new fitness program. As a result, they sent other similar products as a temporary solution. Customers could ask for the product that they ordered and they would be put on a waitlist – essentially asking for 2 products for the price of one.
Manage Your J Curve
J curves need to be managed because they can easily get out of control, leaving a large mess to clean up. Some of the factors you need to look at when managing your j curve include assessing the type of sales you are having and the ideal sales, the timing of when you purchase materials, and managing (retaining) your talent. Remember, the quicker you grow, the faster you run out of fuel.
Types of Sales
There are good sales, and then there are bad sales. We’re talking about the types of products/services you’re selling and who you are selling to. If you accept both good and bad sales, you are not managing your j curve effectively. Maintaining healthy profit margins in a high growth situation is also critical. Sometimes, it can be more productive and profitable to fire a particular customer than take their money.
Timing of Purchases
Ever had to purchase something without having cash in your pocket? If you’re like most people, then you would defer that payment until you have cash. But companies disregard their habits in their personal lives… Sales means cash, right? Wrong. Work with your vendors to delay payments until you have cash in the bank.
Your talent is one thing you need to look at when managing your j curve. The reason is because with increased growth comes increased stress. If you are not taking care of your employees, then employee productivity and morale is going to decrease and eventually, turnover. We all know that high employee turnover is a cause of bleeding cash in you business. First, there’s decreased productivity that makes product produced or sale made that much more expensive. Then, there’s severance and continuing benefits for a certain amount of time. Finally, there’s the expensive hiring process that potentially includes staffing, recruiting, hiring, training, etc.
Effective Business Planning with a J Curve
Focus on the cash flow and profitability of your company. We show every company that we work with in our consulting practice and coaching workshops how to improve its profits and cash flow. When it comes down to it, that’s all the business is made up of. And every company, regardless of whether you are in a fast growth company or not, needs to effectively plan using cash flow forecasts and reports, flash reports, and flux analysis. If you are seeking more ways to make a big impact in your company, download the free 25 Ways To Improve Cash Flow whitepaper to find other ways to improve your cash flow within 24 hours.