Growth is good and as Gordon Gekko said in the movie 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. But 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 midsize 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 prospective clients are good credit risks or able to pay their bills on time. Staffing firms must pay their workers 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. And when a normally “good” client misses payments, the collection department may even be asked not to become too aggressive on past due payments to avoid alienating them. But as days sales outstanding pile up, so does the potential seriousness of the problem. Running a business should be a balance of risk and reward; looking at just the reward without assessing credit worthiness is risky business.
Even if your client pays its bills a little late, growing too fast can grow yourself right into bankruptcy. For example, take a tech staffing company that has an available line of credit of $300,000 and minimal free cash reserves. If it adds 12 new contractors on assignment at an $80/hour bill rate, its receivables increase by $166,000/month. And if the client does not pay its bill for 60 days, the company’s A/R will rise by $332,000, exceeding that credit line and putting the company in serious cash flow difficulty. Ideally, the company should increase its LOC with the bank in anticipation of taking on large orders in order to stay within prudent credit limits.
Perhaps the staffing firm has ascertained the credit worthiness of that client and set a maximum credit at $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, the firm 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’s end.
Providing competitive prices is a separate business decision from taking on the far greater risk of becoming someone’s banker.
