The aim of most companies is to grow. Some grow a lot and quickly. Remember that rapid growth comes with its own challenges and can often be a direct cause of liquidity issues. We asked Leif Knutas, quality manager at Azets, about what fast-growing companies should bear in mind so as not to run the risk of problems with liquidity.
Why is it important to keep track of liquidity in a growth phase?
“Liquidity is a company’s ability to pay in the short term. That means access to funds that are easy to turn into cash. This determines whether a company can cover its ongoing expenses. Liquidity is important even if there’s a huge inventory or high levels of sales. If the company doesn’t have enough cash, it can be difficult to keep the wheels spinning. The liquidity ratio is actually one of the key ratios that often deteriorates the most before a bankruptcy. This is a challenge that many face when in a growth phase.
Not all go bankrupt, but many run into liquidity problems and lose control when they grow too quickly. The admin apparatus is always playing catch-up – perhaps the company’s stock procedures are too complex as the company grows, or its processes and systems just aren’t suited to large-scale operations.”
What can the consequences be if the company doesn’t have control?
“It’s often things like poorer overviews and too much stock. Many just buy too much compared with what they’re able to sell and fail to monitor and collect all their accounts receivable. So a liquidity crisis can have serious consequences for any company, posing an especially major challenge for growing companies. One of the most important steps a growing company can take is to get help with liquidity management. There are significant benefits to working with a partner that can quickly adapt systems to the company’s needs, help with procedures, and offer good advice. This can be crucial for a company’s future.”
“The company may not discover the bottlenecks until it’s too late”
“With rapid growth and expansion, it’s easy to tie up too much capital in bigger warehouses and new fixed assets for production and operations while outstanding accounts receivable grow in size and number. If the company ties up too much money in stock and accounts receivable, then there’s just no cash left when you have to pay your regular expenses such as wages, accounts payable, taxes, and fees. Eventually you notice how much time you’re spending on dealing with complaints and reminders, and your focus shifts from sales to admin.
In some cases, the goal of growth becomes so dominant that it overshadows other issues. The company may not discover the bottlenecks until it’s too late. Decisions can be made too quickly and for the wrong reasons, which can result in poorer overviews and internal strains within the organisation.”
How can liquidity issues be prevented?
“A prerequisite is ensuring that your accounts are correct and up to date. The easiest way to achieve this is to use a digital accounting system that provides a complete overview of your finances and makes it possible to produce relevant figures easily. This applies whether the company looks after its accounts all by itself or just part of them and gets help where needed, or whether it outsources its accounting completely.”
“Make sure you plan for growth as well. Growth comes at a cost, and although income may increase in the longer term, additional resources are needed during the growth period. Plan growth with long-term loans. This is something that the bank will understand. For this reason, it’s important to contact your bank in advance rather than when you’re in the thick of it. Don’t wait until the cracks start to show. The company must be able to demonstrate to the bank that it has control of its finances and present forecasts for both budget and liquidity.
“A liquidity budget helps to map how much money is available at any given time. In this way, you can ensure that there’s enough in the account when important payments such as wages, taxes, fees, and other bills need to be made. How much will these expenses increase as the company grows? Weigh up whether it’s necessary to hire more staff, whether your staff have the right qualifications, and whether your costs for offices, transport, insurance, hired labour, recruitment, and training will increase. Then assess how your expected growth will affect your liquidity, and budget for this. Some questions to ask yourself include: Does the company need to increase its warehouse capacity? Will accounts receivable increase? How will growth affect interest rates, VAT payments and receipts, taxes, and fees?”
Are there measures a company can take when it starts to lose control?
“Yes, there are. Make sure you get the money that your clients owe. This is where many run into problems during periods of growth as they’re used to manual systems that work well up to a point, but which aren’t suited to a larger business. A company can easily keep track of things itself if there are just four clients to chase for payment, but this becomes much harder when there are 400 clients who haven’t paid and need chasing. This job can be outsourced so you don’t have to spend time on it yourself. It doesn’t cost anything extra, because the debt collection companies charge by way of the reminder fees.
“Also, take control of your inventory in order to free up the capital tied up there. I’d recommend that all companies with inventories of a certain size introduce an electronic stock system. It’s relatively easy to manage one warehouse yourself, but this becomes much harder when the company has five different warehouses in five different locations. You can quickly lose track. Without being in control of which goods sell quickly and those that sit on the shelves, there’s a huge risk of the company stocking items that it just doesn’t make any money on. Also, make sure you get the best possible terms and quickest possible deliveries from your suppliers.”
Want to know more about how to improve your company’s liquidity? Please don’t hesitate to contact Azets.