How Can Companies End up Bankrupting Themselves with Business Growth?
Remember the Wily Coyote? The rangy old coyote would run full bore towards the roadrunner – and right off the cliff. Invariably, he’d run a good few seconds before realizing there was nothing but air beneath him. Levity aside, this is a good analogy for many businesses experiencing rapid business growth. They run, so fast and so furious and so single-mindedly, that they may not realize the ground isn’t as firm as they thought.
Growing, Growing, Gone
A few years ago, BottomLine walked into two bankruptcies. The CEOs of these companies didn’t know that they were so upside that they were insolvent; they thought they just had cash flow issues. It throws a big red flag up for us when leadership is totally focused on growth without a healthy understanding of the profitability dynamic. Both of these companies had similar undercurrents running through them:
They underinvested in their financial shop.
Neither company had strong accounting or bookkeeping processes, and their financials were in rough shape. They were using a cash basis accounting method, rather than an accrual basis (which matches their revenues and expenses). One of the consequences is that a lot of their expenses were not recorded.
If you’re on a cash basis, you can manipulate your situation to look great – by not paying the bills! But this doesn’t accurately convey the reality of the underlying financial dynamics of the business. It’s like putting a painting over a hole in the wall. It doesn’t make the hole disappear.
They didn’t understand their cost structure.
And sometimes, the hole keeps getting bigger. In both situations, for instance, these companies had received substantial deposits and recorded them as revenue even though they hadn’t yet earned the money.
What’s the problem? The companies are growing; deposits are flowing in. Yes, but! If the cost structure is upside down, then they’re basically spending their kid’s inheritance. They are taking someone’s payment for future work and using it to pay current expenses. It’s similar to the old adage of “robbing Peter to pay Paul.” When the wave of deposits stops (which it will), Peter’s going to want his money.
They couldn’t price accurately.
Companies can bankrupt themselves through growth. If they don’t invest in financials, if they don’t have good insight into their cost structure, how are they going to price anything? If they’re growth, top line revenue-oriented, they may be only thinking, “How am I going to get this customer.” Not, “How much is it going to cost,” or, “How profitable will this customer be for us?”
How to Prevent Your Company from Growing Broke
We advocate having your management financials on an accrual basis. If, for example, you receive a large deposit, you don’t book it as revenue, but as deferred revenue. Essentially, you allocate the deposit over the period of time you’re going to be working on that project. That way, you match the money with the labor and materials that you’re purchasing.
When we come in to a business that is in danger of bankruptcy, we have to go back and recreate events. We match revenues and expenses to see what the cost structure looks like. If your costs are sharply higher than your revenues, then you have to adjust your pricing or your expenses. But before we can get to that point, we have to understand what we’re dealing with. Are particular lines of business driving this? Is it a particular customer? We have to peel back the layers of the onion to determine the factors driving the company bankrupt.
The Earlier, the Better
If we can get into companies in the earlier stages, BottomLine can help leaders achieve better insight into their financials and make solid decisions. When companies wait until they’re knee deep, they could be so upside down that there is no way but bankruptcy. We want to avoid that by working with companies to put the right structure in place before the last resort is the only option.
It’s easy to focus solely on growth and top-line revenue, but the risk is running straight into bankruptcy. The right financial systems and processes can give you a safety net – but better, they help you avoid the cliff altogether.