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Beware of the J Curve

J Curve

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!

Cash Conversion Cycle (CCC) =Days Sales Outstanding (DSO) + Days Inventory Outstanding (DIO) – Days Payable Outstanding (DPO)

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

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.

Talent Management

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.

 

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Why do most startups fail?

why most startups fail

Right now is the time of innovation – kickstarters and new types of marketing campaigns are popping up everywhere. You might have an idea yourself, regardless of whether you’re a Millennial, Generation X, or even a Baby Boomer! So how do you know if your idea is a good one?

As I have mentioned in previous posts, I am an adjunct professor at the University of Houston Wolff Center for Entrepreneurship. In one of our first classes, we discussed an interesting topic: the survival rate of a new business, and why most startups fail.

According to Fortune, 9 out of 10 new businesses fail. The number one reason for why most startups fail was not having a product that serves the market. I asked the students this question, and now I’ll ask you… Do you think a good product is enough to survive in the market?

Top 5 Reasons Why Most Startups Fail

The answer to that question is no. A number of factors play into why most startups fail. Here are a few:

#1: People don’t need it!

The number one reason for the failure of a business is creating a product for a market that doesn’t need it. The first thing you should do, before you spend all of your cash on producing and prototyping your product, is market research. Who is your customer? How many customers are out there? How much are they spending on a product that serves a similar function? If you can’t answer all of these questions about your idea immediately, then maybe this isn’t the best business to invest in.

 #2: Cash wasn’t King

Where are you spending your money? Research shows that 29% unfunded startups fail because they ran out of money. We can assume that they spent the money on research and development, marketing, salaries, and other overhead expenses. How did they run out of cash in the first place? Because the financial leaders overlooked important, and possibly tedious details.

Also consider that different businesses see profits at different times. You may go 5 years without seeing a dime. Or maybe it’s the other way around –  some startups might skyrocket after a couple of years. But do they have enough cash to keep them afloat? Looking ahead is always important when you manage your finances. Like gas in a jet, cash is the fuel to keep your business running. Cash is king.

Even if you aren’t starting a new business, taking a look at your company as a whole is always a good idea when making big decisions. Download our free Internal Analysis whitepaper to learn how!

#3: Lack of a Quality Team

why most startups failObviously when you start a company, you want the best staff you can build. However, most startups can’t afford “the best of the best.” There may be certain skills that you need, tasks that need to be done quickly, but your staff simply cannot keep up.

Let’s say your team has all the skills you need, but they don’t communicate or work well with others. You’ve just invested your money in a team that could fall apart. It’s better to a have a team that learns the skills and has a positive attitude, versus a skillful team with a negative attitude. In this case, quality is defined by the talent in the person, not just the skills they bring.

#4: No Competitive Advantage

On top of marketing research, you also have to conduct competitive research when you start a business. What makes your company unique? In a way, a condensed competitive scope may indicate that your product is needed. What you have to figure out is how to make your brand more attractive than your competitor’s.

This means more than just “being the cheaper alternative.” The intellectual property itself has to have that secret sauce… which also means that you answer your customer’s problem better than your competition.

#5: Poor Pricing

Poor pricing is another reason why most startups fail, so don’t underestimate the power of smart pricing.

The Startup Roadmap

Solve a Problem > Build a Good Team > Research/Develop the Idea >

Financial Projections > Look for Funding > Develop Product >

Disrupt a market.

This is a general roadmap of a startup. Typically, it takes 3 years to be successful in an industry. Think about it – when you apply for a job, they look for people with 3+ years experience. Why? Because they have 3+ years experience in a skill set. The interviewee knows how to navigate a problem and has practiced solving it. Same goes for a business.

Why Banks Turn Startups Away

The research pwhy most startups failreviously mentioned shows data for companies that have been around 3-5 years. I like to think that after you pass the first three years, things get easier for your company. For example, banks need to see at least 3 years of financial statements. You may not need profits for all three years, but you should be trending upward by year three for banks to consider investing in your business.

Banks turn away companies less than three years old for multiple reasons. One is that new or small businesses are more risky than larger businesses. Post-recession, banks have to be more strict with who they lend to. Banks also earn less profit on smaller loans. If you think about it, banks underwrite a $5 million loan for the same cost of underwriting a $50,000 loan. It makes more sense to focus on the larger loans, with a less risky business.

Conclusion

Although it seems like everyone around you is looking for that next big idea, really think through your next venture. Do you have a market, cash, and a good team? What is your competition like? And finally, what is your pricing strategy? If you create a roadmap and make financially sound decisions, your startup should already look better than most.

Speaking of making financially sound decisions, check out our free Internal Analysis whitepaper to assist your leadership decisions and create the roadmap for your company’s success!

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