What Is Your Sustainable Growth Rate?

Believe it or not, many companies fail just as they are poised to take off. The requirements of business growth present significant obstacles for unprepared firms. The most common pitfall appears when business growth outpaces the company’s reasonable ability to support it.

This concept finds easy illustration in balance-sheet-heavy businesses such as manufacturing or distribution. These models add inventory and accounts receivable (current assets) in anticipation of or as a result of increasing sales. It’s also quite common for expanding companies to add additional assets like real estate, leasehold improvements, technology, or equipment and furniture. In order to pay for this growing balance sheet, the company’s debt and equity must remain in balance. The goal in managing liquidity is to ensure that liabilities do not grow faster than equity. Financial managers in these types of businesses monitor two important indicators:

• The current ratio (current assets ÷ current liabilities), which measures liquidity, or their ability to pay their bills

• The debt/equity ratio (total liabilities ÷ equity), which measures risk, or their ability to withstand adversity

A declining current ratio may mean the business does not have enough liquid assets to convert to cash in order to pay off obligations due in a one-year period. A rise in the debt/equity ratio may indicate that the business is not retaining enough profits to increase equity, meaning they must borrow more to fund the increase in assets. Both ratios help reveal if a firm is adding assets too fast or, in financial management terms, not turning over current assets fast enough.

When observed over periods of months and years, and compared to relevant benchmarks, these ratios provide early warning signs. This insight allows you to make adjustments to your business by raising prices, reducing expenses, increasing the pace of collecting receivables, slowing inventory purchases or even selling inventory at a discount to get it off the balance sheet.

Financial advisory firms may not seem balance-sheet-heavy in the traditional sense, though fee collection can be regarded as an accounts receivable or pre-paid asset. Unfortunately, this means that owners may overlook the potential strain on the firm’s financial health until it’s too late. Advisory firms have other “asset” and “liability” growth problems as well, in the form of people whose compensation and related expenses also need to be funded out of current cash flow.

These cash flow requirements cause owners to pause before adding staff of any kind. If they add another advisor without enough clients, how will they pay for her? If they take on non-client-facing support staff, will they be able to cover these added costs and still take home a decent paycheck for themselves? If they hire a general manager or COO to run the business more efficiently, will this free them up enough to bring in clients, and will these clients cover the expense of professional management and also produce a return on investment?

Not adding staff has a price, however. If owners take on more clients than they can adequately support, what will happen to the client experience and the firm’s reputation? Will clients wish to stay with the firm, let alone recommend it to others? What about the risk of error? Or the damage from compliance oversights?

These are all good questions. If you are trying to grow your advisory firm, it’s important to understand one absolute truth: The lack of physical capacity is the single biggest inhibitor to growth.

This argument surprises many who believe that the key to success is attracting new clients. While business development is important, the advisory profession for the most part is not suffering from a dry spell in revenue growth. Rather it is strained by the weight of more clients, more demand for attention and more opportunities to expand into new markets.