Merchant Cash Advance Digest

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When times in your business are good, you want to accelerate your business growth, and when times are tough, you want to put on the brakes. This is easy to say, but much tougher to do.  You can manage the growth of your business by many means, including inventory expansion or layoffs.  Your forecast can either be long-term or short-term, depending on your confidence, and the ways you manage growth should match your confidence.

Let’s estimate how retailing will do for the next 5-10 years….
Estimating the tailwind and headwind is tough, but not impossible.  Take a look at the year-over-year growth treneds in the U.S.  according to the Department of Commerce (see attached graph).  You could do trend-line analysis or difference-from-average analysis to give you some ideas.  Some rules that have held more or less true over many years in the U.S. is that it is typically 7 years from peak to peak and 2-3 years from peak to trough.  Or, another way of looking at it, you could say typically you have about 4-5 years of continuous growth from each trough before the next peak.

So, how shall we apply that to managing growth?
For starters, signing a humongous lease for property at the peak is a bad idea (countless examples of this exist).  Conversely, cutting advertising at the trough is a mistake (see WSJ article pg B5,  1/12/2010).  Let me assert this:  We had our trough in Feb-09 in the U.S.  The stock market took a month to recognize this and bottomed soon thereafter.  So, if the pattern holds, we’ll experience growth till Feb-15 to Feb-16, then experience 2 to 3 years of downfall.

When is the best time to take risk?
At the trough, or early in the growth phase.  We are there now.  That is because prices are cheapest for inventory, and you can make the assumption that you’ll be able to pay your contracts off with more and more dollars in the next 4-5 years due to growth.

When is the best time to cut back on risk?
At the peak.  Ideally, you’d have no debt whatsoever.  And if your business performs like the US retailing revenue trends, you’d want to brace yourself for a 10-15% revenue pullback, but trimmming inventory, lower costs and the like.

What is the impact of taking on debt and investing it into your company at the right time?
Lets say you had $100,000 of inventory and could sell it for $200,000 over the next year, and that your business made $50,000 in profit after expenses.  (Example #1)

Now, imagine you could instantly double inventory to $200,000 and sell it over the same one year at the same margin.  You’d have $400,000 in sales, minus the cost to finance and manage the growth.  Lets say the cost to finance is 30% over a one year term, and you have to grow your expenses 50% to double sales.  Over seven years, you could make $530,000 in profit by borrowing for four of the years.  (Example #2)

If you didn’t increase your inventory, and revenues remained relatively flat, you’d make $350,000.  Not bad either, but not as much.  Yes, you’ll pay the bank $120,000, but you’ll make $180,000 more yourself.  See Figure 2.

What is the wrong way to do this?
Lets say you had the same company with $100,000 of inventory that would sell for $200,000 over the next year, and that the business made $50,000 in profit after expenses.  Imagine you wait 3 years because you didn’t want to “pay the bank” the $90,000 to borrow $300,000 for three years.  Imagine further, that with your business having been quite stable, with relatively steady profits and a non-volatile growth pattern, you finally convince a lender to make you a 4 year loan at 15% cost per year.  I’ll show you what that looks like.  You’d make $50,000 a year for 3 years, just like the no-growth plan.

Then you’d skyrocket to $185,000 at Year 5.  Then you’d end up making $3,000 and $22,000 in years 7 and 8, which probably wouldn’t cover your personal bills and you’d have to shut the company down.  (Example #3).

Lets argue about financing costs and its impact on your profits.

Using the same company in the growth scenario with 1 year term capital, assume the cost of capital is not 30% per year, but 50% per year.  (Example #4)

You still make more than you would without taking on debt, a cool $500,000 over eight years.  Lets pay 70% per year, just for arguments sake.  You still make more than if you took on debt, coming in at $420,000 versus the $400,000 no debt situation.  (Example #5)

Now, take the scenario where you chose to get a 10% cost of capital for a 5 year term.  You still go bust in Year 7 and 8, except you made $190,000 in the peak year. (Example #6).

So, lets go over this again.
You want to borrow money and expand your business when:  you are experiencing growth.  You want to cut off the borrowing before growth slows, so that you continue to make profits, because unless you are special, your sales will decline just like everyone else’s.  Some companies are very special; the vast majority are just pretty good.
When to use short-term financing.  When to use long-term financing
The easiest way to figure all this out is to make sure you use short-term financing when is most appropriate.  Times to you it is when you are close to the peak.  That way, your debts are paid off quickly if revenues tail off.  You can recover from it.  The best time to get long-term financing is at the beginning of the growth phase.  That is ideal, because you have 4-5 years to pay it off and revenues are likely to grow anyway.  Our experience, though, is startups and small businesses cannot get long-term
financing at the early growth phase of an economic expansion.  Look around right now, for example.  Despite the fact that the U.S. economy troughed in Feb-09, throughout 2009, the number of SBA loans was 1/4 as many as just three years prior.  It is tough for small businesses to get long-term financing.  We argued above that even at really high rates of financing that a small company can do better by growing inventory, as long as the business model and margins hold generally true.

Summary.
Consider grabbing almost any capital you can at the right time, whether it is long-term or short-term.  As you approach the peak, take on shorter-term capital.  In the down-phase, make sure you have already paid off the debt so you don’t have to sell your hard assets to survive.  Now is the time to raise capital for your company.  Don’t wait years and limit your growth, only to lock in a long-term deal at the peak just because you got a lower rate.  You will look smart at the peak and then lose it all.  Better to grow step-wise and manage the business the way you want, not the way the contract you signed last year demands.