Your brand has a growth speed limit

TLDR

• Profitable growth can consume cash faster than your business generates it. Every brand has a natural speed limit on how fast it can grow without outside capital.
• You can estimate that limit. It depends on how much cash your business generates and how much additional working capital growth requires.
• Capital planning comes before growth planning. Know how much growth you can fund yourself, secure the right capital for the rest, and only then commit to the growth plan.

The cash you need to keep the machine running

The cash tied up in your business = inventory + what customers owe you - what you owe suppliers. This is the operating working capital or net working capital. Expressed in financial terms it is Inventory + AR - AP.

Expressing this as a percentage of sales helps because it provides a metric to understand the capital intensity of your business. And you can compare this to other brands. At no growth, the cash tied up in the business (your net working capital) stays the same.

The incremental cash needed when you grow

When you grow, you have to pay for that additional inventory before you sell it and wait to collect on more sales, which causes your net working capital to increase.

Let’s say you are doing $10 million in sales. Your net working capital needs are 20% or $2 million. To grow 30%, you need roughly 30% more net working capital. If you keep the same inventory levels, payment terms, and supplier terms, 30% more sales means 30% more inventory, 30% more receivables, and 30% more payables, so net working capital grows 30% too.

30% growth means you need $600,000 more net working capital ($2 million * 30% = $600,000). Remember you have to fund that net working capital in advance of the increased sales. This increase needs funding.

How much cash do you produce?

You are profitable, so your business can produce cash. But EBITDA is not the same as the cash available for growth. When you are profitable, you have taxes to pay. And there are usually some maintenance CapEx items. When you have no debt, your EBITDA - Taxes - Maintenance CapEx is your cash for growth. Let’s say you have a 10% EBITDA margin, your cash for growth might be 6% of sales (10% EBITDA - 2.5% taxes - 1.5% maintenance CapEx).

For simplicity, we're assuming no debt, no owner distributions, and no unusual cash expenses. We calculate changes in working capital separately.

Determine how much growth your cash production can support

Your cash for growth as a percentage of sales is 6%.

Your net working capital as a percentage of sales is 20%.

Divide your cash for growth as a percentage of sales by your net working capital as a percentage of sales to get your approximate growth speed limit e.g. 6% / 20% = 30%.

The more cash you keep for every dollar of sales and the less of each dollar of sales you need to fund net working capital, the higher your self-funded growth rate. And of course the inverse is true.

This is a planning approximation, not a precise maximum. It uses the cash generated by your current sales base and assumes your working capital intensity stays constant. Your actual capacity depends on when growth happens, when cash is collected and paid, and how much additional cash the growth itself generates.

Putting it together

At $10 million in sales, your 10% EBITDA margin is $1 million, and your cash for growth is $600,000. Growing 30% requires $600,000 more net working capital. Your cash production exactly covers it, so 30% is your speed limit.

What does it mean?

Don’t create the need for capital before you know how you will get the capital. Too often, brand leaders will set growth goals without understanding how they fund the growth. They set the plan, launch the ads and then start thinking about how to fund it. A 60% growth goal sounds great. But if you can only fund half of that yourself, it means you are going to need a lot of outside capital for the rest. Better to ask before launching the plan if your ability to get that capital in the structure in which you need it matches your goals. Otherwise, by the time you need the capital, you're forced into less than ideal structures like unmatched short term loans, and the debt spirals begin.

Improve your ability to self fund growth while you get outside capital. More importantly, understanding how the growth speed limit is set enables you to work to make permanent changes to the underlying assumptions. For example, let’s say you increase prices, reduce OpEx and find ways to double cash for growth as a percentage of sales. You can now self fund that 60% growth. And you can work on your capital efficiency by decreasing days inventory, decreasing AR or increasing AP. The result is net working capital drops to 15% of sales. On its own, that raises your speed limit from 30% to 40% (6% ÷ 15%). Combined with the doubled cash for growth, it rises to 80% (12% ÷ 15%) and your 60% growth goal is now comfortably self-funded.

In future posts I will cover what this looks like for unprofitable brands, why cycle matching is critical for funding net working capital and how the right capital structure applied to inventory financing completely changes the game.