“Growth is good” and as Gordon Gekko said in Wall Street “greed is good”. To put both comments into perspective everything has its’ limits. Growth is good as long as it can be managed, that growth is sound and it can be financed. Growth for the sake of growth is not a good strategy. Investing in the wrong properties is not good in the game of Monopoly or the real world.
Too many small to mid sized businesses will take on any business they can get at their minimum margin rate. As they try to grow the business all too often they don’t adequately consider whether or not their clients are a good credit risks or the ability to pay their bills on time. The company of course has to pay for their goods or services on a timely basis and if they have long payables or worse need to write off a bad debt on a large account they will either eat into their line of credit or may even put the company in financial jeopardy. When the company has been doing business with a “good” client, the collection department may even be asked not to become too aggressive on past due payments as not to alienate them. But as account receivable days outstanding pile up so does the potential seriousness of the problem. Running a business should be balancing of risk and reward, looking at just the reward without assessing credit worthiness is risky business.
But even if your client pays their bills albeit late, if you grow too fast you can grow yourself right into bankruptcy. For example if you are a tech staffing company and have an available line of credit of $300,000 and minimal free cash reserves and then you have added 12 new contractors on assignment at an $80/hour bill rate. You will have increased your receivables by $166K/month. And if the client does not pay his bill until 60 days your A/R will rise by $332K. You have then exceeded your line and you may be in serious cash flow difficulty. Ideally the company should increase their LOC with the bank in anticipation of taking on large orders and as staying within prudent credit limits. Some clients, for the privilege of doing business with them, don’t pay their bills in 90 days to make money on the float.
Assuming that you have ascertained the credit worthiness of that client and their maximum credit should be $40,000 which would cover one contractor, with payment terms of 30 days. But adding 12 contractors should carry payment terms of 1 week. Alternatively you could have asked for payment in advance, or a deposit, based on the number contractors and hours they are scheduled to work, with adjustments made as necessary at week end. Providing competitive prices is a separate business decision from taking on the far greater risk of becoming someone’s banker.
To see all articles in this series please go to http://optimal-mgt.com/blog.
