Saturday, March 2, 2024

The Hidden Pitfalls of Business Growth:


This individual runs a thriving therapy business in the southern US, and her rapid growth presented a financial challenge that many businesses face without even realizing it.

The Story Unfolds:

This therapist, talented in her field but lacking extensive business experience, sought a business loan to address what she perceived as a need for additional operating capital. Intrigued, I had a conversation with her to delve into the intricacies of her financial situation.

The Quandary:

On the surface, her business seemed healthy. Charging $139 per therapy session and paying her assistants $50, she appeared to have a robust gross margin. 

However, she consistently found herself without enough money to pay herself, despite what seemed like a successful practice.

The Issue: Growing Pains and Cash Flow Timing:

Upon closer examination, it became evident that her growing business was facing a common challenge—cash flow timing. 

She was adding multiple new clients each week, but the insurance companies she worked with took 30 to 45 days to process payments. 

Meanwhile, she paid her assistants every two weeks. The result? A significant gap between the money going out and the money coming in.

The Danger of Financing the Value Chain:

This situation highlighted a crucial point: when your receivables (what you're owed) grow faster than your payables (what you owe), you find yourself in a perpetual need for higher operating capital to finance your customers.

 Essentially, you're inadvertently financing the value chain of your business.

The Illusion of a Loan Solution:

The initial inclination was to seek a business loan to alleviate the short-term pressure. 

However, I cautioned against this approach. 

While a loan might provide temporary relief, it wouldn't address the underlying issue. 

If the business continued growing at the same pace, the borrowed capital would ultimately be consumed by the need to finance the insurance companies' delayed payments.

The True Solution: Matching Receivables with Payables:

The key to resolving her financial challenge was to extend her payables. 

By changing the payment terms for her assistants to align with the typical payment cycle from insurance companies, she could match the money she's owed with the money she owes to others.

 This would prevent her from unintentionally financing the activities of the insurance companies.

A Valuable Lesson: Financing Wisely:

This scenario highlights the importance of keeping a close eye on your payables and receivables. 

Businesses should be cautious about taking on debt unless it's to acquire assets that will generate profit over time. 

Borrowing to meet short-term financing needs, especially when it involves financing customers' activities, can lead to a cycle of interest payments without significant benefit.

Closing Thoughts:

It's a reminder that businesses should strive to match receivables and payables, ensuring a healthy cash flow.

Whether it's through credit terms with customers or strategic payment schedules, businesses can navigate growth more effectively by managing their cash flow wisely.

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David C Barnett

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