By Marc Obadia, Founder, Rock Drive Business Capital

Rising sales are usually taken as a sign that a business is becoming financially stronger. More customers, larger orders and increasing revenue should mean more money available to the company.

In practice, growth can produce exactly the opposite result.

A business can report increasing sales and even be profitable on paper while simultaneously struggling to meet payroll, pay suppliers or cover its normal operating expenses.

This is sometimes described as a working capital gap. It occurs because revenue, profit and cash are different things. A sale can appear in the accounts long before the corresponding cash reaches the company’s bank account, while many of the costs associated with delivering that sale have to be paid much sooner.

Understanding this distinction is particularly important for growing businesses because expansion frequently requires additional cash before it produces additional cash.

Here are some of the main reasons successful growth can put pressure on cash flow – and what business owners can do about them.

1. Sales do not necessarily mean immediate cash

Consider a business that increases monthly sales from £100,000 to £150,000.

At first glance, that additional £50,000 of revenue appears entirely positive. But suppose customers are given 30- or 60-day payment terms.

The business may need to purchase materials, pay employees, cover transport costs and meet other expenses associated with those additional sales weeks before customers actually pay their invoices.

The faster sales increase, the larger this timing difference can become.

This is one reason a growing company can appear increasingly successful on its profit and loss statement while its bank balance becomes progressively tighter.

Owners therefore need to pay attention not only to how much they sell but also to how quickly those sales turn into cash.

2. Inventory can absorb cash during growth

Businesses that carry inventory face another challenge.

A retailer, wholesaler, manufacturer or distributor experiencing increasing demand may need to purchase substantially more stock.

Those purchases often happen before the resulting products are sold.

Suppose a distributor expects a busy period three months from now. It may need to place larger orders with suppliers today to ensure sufficient inventory is available.

Cash consequently leaves the business before the corresponding revenue arrives.

If sales continue growing, the company may repeatedly reinvest available cash into additional inventory. The business can therefore become more valuable and profitable while having surprisingly little unrestricted cash available.

Inventory management becomes particularly important in this situation. Owners should monitor how quickly products sell, identify slow-moving inventory and avoid tying up unnecessary capital in stock that may remain unsold for long periods.

3. Payroll increases before expansion pays for itself

Hiring provides another example of the financial pressure created by growth.

A company may need additional salespeople, drivers, technicians, administrative employees or managers before those employees generate sufficient additional revenue to cover their costs.

Payroll, however, cannot normally wait until the growth strategy succeeds.

Employees must be paid according to the normal payroll schedule.

The same principle applies to expenses such as insurance, software subscriptions, rent, vehicles and professional services.

This creates the upfront cost of growth. Businesses frequently have to increase their cost base before receiving the full financial benefit of expansion.

4. Larger customers can create larger cash-flow gaps

Winning a major contract can be an important milestone for a growing company, but larger customers can also create financial pressure.

Imagine a contractor that wins a project significantly larger than its normal jobs.

The contract may require additional labour, equipment and materials. Suppliers and employees still need to be paid, but the contractor might receive payment from the customer only after reaching particular project milestones or submitting invoices.

Similarly, a wholesaler supplying a large retailer may have to deliver substantial quantities of goods before receiving payment.

The contract may ultimately be profitable, but the business needs enough cash to finance the period between performing the work and collecting the money.

This is why owners should evaluate the cash-flow consequences of a major new customer alongside the expected profit.

5. Profit and cash flow measure different things

One of the most important financial concepts for business owners is that profit and cash flow are not interchangeable.

Profit broadly measures whether revenue exceeds expenses over a particular accounting period.

Cash flow measures the actual movement of money into and out of the business.

A company can therefore be profitable but cash-poor.

For example, a business might record revenue when an invoice is issued. If the customer has not yet paid, however, that revenue does not provide cash that can immediately be used for payroll or supplier bills.

The opposite can also happen. A company may make a large payment that affects cash immediately even though the accounting expense is recognised over a longer period.

Business owners should consequently review both profitability and cash-flow information rather than relying exclusively on sales or profit figures.

6. Growth can expose weaknesses in payment terms

Rapid growth often makes existing payment arrangements much more important.

Consider a company that pays suppliers within 15 days but allows customers 60 days to pay.

When the business is small, the gap might be manageable.

As sales increase, however, the amount trapped between supplier payments and customer receipts can grow substantially.

Owners should therefore examine both sides of the equation.

Can customers be encouraged to pay sooner? Can deposits or progress payments be requested on appropriate contracts? Can invoices be issued more quickly? Can supplier terms be renegotiated?

Even relatively small improvements in the timing of payments can have a meaningful effect as revenue grows.

7. Unexpected expenses do not disappear during expansion

Growing businesses still experience ordinary financial surprises.

A vehicle may require an expensive repair. Equipment can fail. A customer might pay late. Material prices may rise unexpectedly. An important project could take longer than anticipated.

The difficulty is that a rapidly growing company may already be using much of its available cash to support expansion.

That leaves less room for unexpected expenses.

Maintaining an appropriate cash reserve can provide valuable protection. The amount required will vary considerably depending on the company’s industry, fixed expenses, customer payment cycles and predictability of revenue.

The important principle is to avoid assuming that every pound or dollar currently available can safely be reinvested into growth.

Build a rolling cash-flow forecast

One of the most practical ways to identify a potential cash shortage is to forecast it before it occurs.

A rolling 13-week cash-flow forecast can be particularly useful for businesses with changing revenue and expenses.

The forecast should estimate expected cash coming into the business and cash going out each week.

Incoming cash might include customer payments, recurring revenue and other expected receipts.

Outgoing cash might include:

• Payroll
• Supplier payments
• Rent
• Taxes
• Insurance
• Inventory purchases
• Loan or financing payments
• Equipment expenses
• Marketing
• Transport and logistics
• Other operating costs

The purpose is not to predict every figure perfectly.

Instead, it gives the owner visibility.

If the forecast suggests that cash could become tight six or eight weeks from now, management has considerably more time to respond than if the problem is discovered when a major payment becomes due.

Plan financing before cash becomes critical

Not every temporary cash-flow gap requires outside capital. Businesses may be able to improve collections, negotiate supplier terms, reduce unnecessary inventory, postpone discretionary expenditure or use retained cash.

But there are situations where external capital can form part of a company’s growth plan.

The important point is to consider financing before the business is facing an immediate cash emergency.

Different business financing options can be structured differently in terms of repayment frequency, duration, qualification requirements, cost and intended use. Business owners should compare the overall economics of an option rather than focusing solely on the amount of capital available or the size of an individual payment.

Some businesses may require capital for a specific equipment purchase. Others may be managing temporary working-capital needs, inventory purchases or the costs associated with fulfilling new contracts.

The appropriate structure depends on why the money is required and how the business expects to repay it.

Another structure businesses may encounter is Rock Drive’s revenue-based financing options  where financing and repayment characteristics can differ from those associated with conventional term borrowing.

Whatever form of capital a company considers, owners should understand the total repayment obligation, payment frequency, fees, duration and impact on future cash flow before making a decision.

Measure the cash conversion cycle

Businesses experiencing rapid growth can also benefit from understanding their cash conversion cycle.

In simple terms, this examines how long cash is tied up in normal business operations before returning to the company.

For an inventory-based business, the cycle might begin when inventory is purchased. The products then have to be sold, invoiced and ultimately paid for by customers.

Reducing the amount of time involved can release cash.

Businesses can look for opportunities to:

• Improve inventory turnover
• Invoice customers promptly
• Follow up overdue accounts receivable
• Review customer payment terms
• Negotiate appropriate supplier terms
• Collect deposits where commercially appropriate
• Reduce unnecessary purchasing

Individually, these changes may appear relatively small. Together, they can materially improve the amount of cash available to support growth.

Watch the right numbers

Sales growth remains important, but it should not be viewed in isolation.

Owners of growing businesses should regularly monitor several financial indicators, including:

• Cash available
• Accounts receivable
• Accounts payable
• Gross margin
• Inventory levels
• Inventory turnover
• Customer payment times
• Upcoming payroll and tax obligations
• Debt and financing payments
• Expected cash requirements over the next 13 weeks

Monitoring these numbers helps management distinguish between profitable growth and growth that is placing unsustainable pressure on the company’s finances.

Growth needs cash as well as customers

Increasing sales is a positive development, but successful expansion requires more than demand.

Businesses need enough cash to purchase inventory, pay employees, deliver orders and continue operating while waiting for revenue to turn into money in the bank.

That is why a temporary cash shortage does not necessarily mean a growing business is unprofitable. In some cases, the shortage occurs precisely because the company is growing.

The key is recognising the potential gap early.

By monitoring cash flow alongside profitability, forecasting upcoming requirements, managing receivables and inventory carefully and evaluating funding well before cash becomes critical, business owners can put themselves in a much stronger position to turn increasing sales into sustainable long-term growth.

About the author

Marc Obadia is the founder of Rock Drive Business Capital, which provides educational resources for business owners on business financing, working capital and cash-flow management.