Growth Rate Too Low
If a company grows too slowly, (that is, at a rate less than its sustainable growth rate – see related article) for an extended period of time, it will generate more cash than it needs for reinvestment. If its sales growth rate is below its sustainable growth rate for too long, the company must take action. Options include:
- to accumulate assets;
- to distribute money to shareholders; and / or
- to find investments which will increase its rate of growth.
Growth Rate Too High
A business can actually grow too fast. This sounds like a good problem to have, but it can be fatal. If a business grows too rapidly (that is, at a rate greater than its sustainable growth rate – see related article) for an extended period, it needs more money for reinvestment than it’s able to generate.
For example, payment for current sales may not be received for several months, so accounts receivable may increase. But payroll and other bills must be paid today, and they can’t be paid with accounts receivable. They must be paid with cash. If sales are growing too rapidly, this can be a real problem – the company finds itself constantly short of cash and, in extreme cases, unable to pay its bills.
What this means, tragically, is that a company can be destroyed by its own success.
A deficiency in cash flow can be difficult to alleviate. Improvements in efficiency and profitability may be difficult to achieve and the retention rate (i.e., cash left after making dividend distributions) can’t be increased beyond 100%. For a while, the company can increase its leverage (i.e., borrow more money), but eventually it will reach its credit limit. Creditors will refuse to extend additional credit, and the company will be unable to pay its bills.
If its sales growth rate exceeds its sustainable growth rate for very long and it is unable to increase its efficiency or profitability, the company must take action to relieve the pressure on cash flow. Options include:
- to sell equity;
- to increase leverage;
- to increase the retention rate (i.e., pay less dividend distributions);
- to reduce unprofitable customers, inventory, or activities;
- to out-source support functions;
- to increase prices;
- to turn business away; and / or
- to sell the business or part of the business to an individual or business with a greater capacity to invest.