Q: What would you consider too aggressive of sales growth?
A: Very subjective, but anything around 15% or above will generally exert a negative cash impact on a company’s cash flow by virtue of movements in the balances of the operating balance sheet accounts such as receivables, inventory, payables, and accrued liabilities. The impact of such sales growth on the bottom line depends on the company’s ability to maintain its fundamental profitability sufficiently robust in a strong growth environment so that it can accommodate increases in financing and associated interest expense.
The cash impact of sales growth depends on the composition of the balance sheet. For example, if a company has very few receivables, inventory, payables, and accrued liabilities, it may grow at a very robust sales growth rate with little negative cash impact from changes in the balance sheet accounts. This would be especially true if the balances in the receivables and inventory accounts roughly matched the balances in the payables and accrued liabilities accounts. By the same token, if the balances in the receivables and inventory accounts vastly exceeded the balances in the payable and accrued liabilities accounts, then very modest sales growth, e.g., four or five percent, could have quite a negative cash impact from movements in the operating balance sheet accounts.
This does raise the issue of debt capacity, which is primarily driven by a company’s fundamental profitability – best measured by EBITDA% – and the level and composition of its interest-bearing debt. If sales growth contributes substantially to a company’s need for outside financing, it may soon run up against its actual debt capacity. This is an issue we address in detail in our single-topic webinar Debt Capacity and Cash Flow.
Course overview: Advanced UCA Cash Flow Part II of II