Operating cycle

Sales Growth and Cash: The Paradox

Is rapid sales growth good news?

It can be a mixed blessing. It creates the circumstances for greater profit; but requires more cash to finance the larger volumes. Consider for a moment; what happens to the balance sheet, what accounts change when sales grow. Inventory and Accounts Receivable These trading asset accounts are intrinsic to the business Operating Cycle.

Essentially, businesses start with cash, they purchase materials which are processed or manufactured, distributed, sold and finally converted back to cash. While a processing manufacturer example is used here, service, wholesalers and other types of business are essentially similar

There are two types of sales growth, long-term (over a period of years) and seasonal. When sales grow; both Inventory and Accounts Receivable expand. Unless a business is very profitable additional sources of cash are needed from outside the business. Let’s look at an example:

Income Statement

2012 2013 Increase
Sales 1266000  1645000 379800
Profit 75000 97500 22500

 

 

Balance sheet

2012

2013

Increase

Equity

90000

90000

0

Retained Earnings

435000

532500

97500

Accounts Payable

24000 

31200

7200

Credit Line

45000

73500

28500

Total L and A

594000 

727500

133200

 

 

Assets

2012

2013

Increase

Cash

 63000

81900

18900

Accounts Receive

165000

214500

49500

Inventory

 216000    

280800   

64800

Fixed Assets

 150000

150000

0

Total Assets

  594000

727200   

133200

Total Assets increased by £133200, as a result of the sales increase. Accounts payable and internal financing from profit provided some financing, (in this example all the profit was retained in the business) with the balance required from the bank line.

In general the more profitable a business, and the greater percentage of profits left in the business, the fewer problems created by sales growth. With this in mind, sales growth causes the biggest financial problems for:

  • Business with low profit margins
  • Business with large percentage of total assets in accounts receivable and inventory

Consistent and convenient access to short term or working capital finance, can be seen as one of factors that facilitates growth. Additionally it is in the interests of businesses experiencing a sales expansion to understand and support the financing needs of their supply chain.

Woodsford TradeBridge provides financing solutions by leveraging off buyers accounts payable ledger.

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Murray Stevenson
Sales Director
Woodsford TradeBridge