Profitability vs. Revenue Growth
This is the eighth article on “profitability”—a guide to help understand and develop the true significance of its impact on a business: revenue growth, peace of mind and freedom to do about whatever you want to do.
Jimmy is an awesome sales person. He bought a floundering company, worked his sales magic on the customers and in just six years, he was able to break through $8M in revenue. He is telling his family and friends he will break through the $10M mark this next year. But the real story, Jimmy is broke. His payables are stretched out to COD, his bank won’t lend him any more on his line of credit and he is unable to find any other sources of financing. Jimmy’s invested every free dollar he had to grow revenue; he has invested so much he is showing a slight loss over the last two years.
This isn’t a good strategy. Growing revenue just to grow revenue is folly; it only crates bigger problems that the business owner has to deal with. Jimmy’s life has just gotten very complicated. This article is about balancing revenue growth and profitability.
This area gets complicated so please stay with me. Long term revenue growth is more reliant on the health of the balance sheet than about how many more customers will buy the product. A strong sales team with a healthy balance sheet is very scalable (revenue can grow dramatically). A strong sales team and a weak balance sheet will immediately dampen sales growth. A weak sales team with a weak balance sheet – this is the worst combination. See my booklet on understanding the balance sheet for more information on this subject.
A winning approach:
- Get familiar with your balance sheet, especially your key ratios:
- Debt to worth
- Working capital
- Current ratio
- Monitor these key ratios monthly
- Debt to worth should not be more than 3:1
- Working capital should be on a upward trend, above zero
- Current ratio should be at least 1.2:1 ($1.20 in current assets for every dollar in current liabilities)
- Track the trend of these key balance sheet ratios
- Develop a forecast where you build in profit for the year
- Project your revenue, cost of goods, gross profit and overhead/operating expenses by month to get to your net profit number before taxes
- Set the profit target as a percentage of revenue which should be (based on your industry) between 3% and 20%.
- Review your profit target every month against your forecast/budget, fine tuning it until you can attain or exceed this target each month and make sure that your key balance sheet ratios are tracking correctly.
Most of the time there is a direct correlation between profitability and revenue growth. The more profit (left in the company), the stronger the balance sheet and the greater the sales potential and upside for profit. No profit will stifle growth and erratic profit will slow growth.
Have a great and profitable week.
The Business Growth Coach