Why growth causes more cash crises than downturns
Here’s a scenario that plays out somewhere in Britain every week.
A business wins the biggest contract in its history. Everyone celebrates. Four months later the finance director is choosing which supplier to pay, VAT is being quietly deferred, and the managing director is lying awake wondering how a company can be more profitable than ever and closer to the wall than ever at the same time.
It has a name. Overtrading. And it kills more decent businesses than recessions do.
Profit and cash are not the same thing
Everyone knows this in principle. Very few businesses plan around it.
Profit is a measure of what you’ve earned. Cash is a measure of what’s actually in the account. Between the two sits your working capital cycle: the time between paying for something and getting paid for it.
Every pound of growth stretches that cycle. You buy more materials, hire more people, run more vehicles, hold more stock. All of that goes out now. The invoice goes out later, and gets paid later still.
Growth, in cash terms, is an expense.
What it looks like in numbers
Take a business turning over £2m that wins a contract adding £1m a year. Gross margin 25%. Customers pay in 75 days; suppliers and wages go out in 30.
The extra £1m of annual sales means roughly £83,000 a month of additional invoicing, outstanding for 75 days. That’s around £208,000 sitting in debtors that wasn’t there before.
Against that, the extra direct costs run at about £62,500 a month, outstanding to suppliers for 30 days. Call it £63,000 of extra creditors.
Net additional cash requirement: roughly £145,000, tied up permanently for as long as the contract runs.
The profit on that contract is £250,000 a year. Excellent news. It just turns up in instalments, months after you’ve paid for the privilege of earning it. Meanwhile you need £145,000 you don’t have, starting immediately.
(Illustrative figures. The principle holds at every scale, which is exactly why a business can grow itself into insolvency.)
The warning signs
Overtrading announces itself well before it becomes a crisis, if you know what you’re listening for:
- Turnover is climbing and the bank balance isn’t.
- You’re paying suppliers later than you used to, and it’s becoming policy rather than oversight.
- VAT and PAYE have quietly become a source of working capital.
- New work is being funded out of the deposit on the next job.
- Your overdraft, once occasional, is now permanent.
- Debtor days are creeping up and nobody’s chasing, because everyone’s busy delivering.
- You’re turning down work you could win, purely on cash.
The last one is the most expensive, and the one owners are least likely to mention.
What to do about it
Work out the cash cost of the contract before you sign it. Not the margin. The cash. Ask what it costs to deliver, when that money leaves, when the customer pays, and what the gap is at its worst point. If a contract needs £145,000 of working capital, that’s a fact about the contract, and it should sit in the decision alongside the price.
Fund the cycle with a product built for it. This is exactly the job invoice finance and trade finance do. Both scale with turnover, so the funding grows as the contract grows rather than being fixed at whatever seemed sensible last year. A term loan sized for a snapshot in time will be the wrong size within a quarter.
Attack both ends of the cycle. Deposits and stage payments on larger jobs. Invoicing on the day work completes rather than at month end, which alone can pull a week out of the cycle. Proper credit control that starts before the due date. Negotiated supplier terms, which are often available simply because nobody has asked.
Look at what’s leaving the business regardless of turnover. Energy, insurance, telecoms, merchant fees, waste, logistics, software licences. These rarely get reviewed and frequently sit on legacy pricing. Money saved here is worth considerably more than money borrowed, because it doesn’t need repaying. It’s also usually quicker to release.
Don’t fund a permanent gap with temporary money. If the working capital requirement is structural, and with a long contract it is, then a short-term facility just moves the problem three months down the road, where it will be larger and you’ll be more tired.
The conversation to have early
The best time to arrange working capital funding is while you’re bidding, not once you’ve won.
At bid stage you have management accounts that look healthy, a clear story about why you need the money, and no urgency. Lenders reward all three. Three months later, with the contract underway and the cash tight, the same business tells a noticeably worse story and pays more for the privilege.
Nobody ever regrets having arranged a facility they didn’t end up needing. Plenty of people regret the opposite.
The uncomfortable summary
A business can be profitable, well run, growing and insolvent, all at the same time. Insolvency is a cash test, not a profit test.
Growth is worth having. It just needs paying for, in advance, like everything else.
At Compare Your Funding we spend a lot of time helping businesses work out the cash cost of growth before it arrives, and putting the right facility in place to carry it. We also help clients reduce the costs that sit underneath the whole thing, because the cheapest working capital is the money you weren’t going to spend anyway. If you’ve got a contract on the horizon that looks brilliant and slightly terrifying, that’s the right moment to call.
About Compare Your Funding
Compare Your Funding is an independent commercial finance brokerage based in Stockport, registered with both FIBA and the NACFB. We arrange invoice finance, asset finance, property and bridging, trade finance and business loans. Compare Your Funding is a trading style of TGL Solutions Limited.
compareyourfunding.com · 0161 871 9840 · info@compareyourfunding.com