What is your Business’s Speed Limit?

My wife and I have been married for over 31 years. As you might imagine, we agree on far more than we disagree. One area of continual disagreement over this time period has been my driving. My wife suggests, unsolicited most of time, that I drive too fast. Whether it’s in my own neighborhood or on the interstate, she will politely communicate “SLOW DOWN!”

Hence, we will then debate the appropriate speed limit for that particular stretch of road. She will often suggest the speed limit posted by the road sign. I consider the sign to be an advisement of sort and belief that the speed limit should be more a function of road conditions, traffic, and my own personal sense of urgency in arriving to my destination on time.

I find that there is a similar disagreement often times between business owners. “How fast should I grow this business?” Some business owners are very conservative in their judgment about growth. They are quite comfortable with slow or moderate growth sometimes almost coasting their business vehicle with minimal effort.

Other small business owners go way too fast. They are like the drivers that lap me on I-285 on my way to the airport. They drive recklessly with little consideration for their own personal welfare, that of their passengers, or other drivers. These are the same drivers I often than see later on either pulled over by a state trooper or part of a multi-car crash on the side of the highway.

As a driver, I rely upon my own intuition and some government regulation to determine how fast to drive my car. How do business owners make this same determination? I believe it is based on several factors:

  • Experience. A lack of entrepreneurial experience might cause a business owner to either grow too fast or too slow. Since they have not managed a business before, they don’t know what a comfortable growth rate might be. Hence, they might harness the growth of the business as a result of this relative inexperience or might push too hard for growth and then find themselves either crashing the business or running out of resources (fuel) prematurely.

My son is a relatively new driver. At times when I am driving with him I find myself politely suggesting to him to either speed up (infrequently) or slow down (more often). I am sometimes at a loss to explain my rationale to him because it is often times just a gut feel based on my own driving experience.

  • Genetics. I honestly believe that some people are just wired internally a desire to go faster than others. That’s my excuse. I like to drive fast. My wife prefers a slow crawl (just kidding honey). Business owners are the same way. Some just have a greater tolerance for risk and are quite comfortable growing their business at a pace that would give others heart failure. While these business owners are not blind to the pitfalls of hyper growth, they are confident they can overcome these obstacles and still maintain rapid growth.

These “drivers” remind me of one of my favorite quotes: “Fixing a small business is like changing a flat tire on a car….at sixty miles an hour.”

  • Availability of resources. While I might like to be able to drive 75 mph on Ga 400; it is difficult to do that if I run out of gas, have bald tires, or have faulty brakes. My car needs to be in good working order to support my “need for speed”. Business owner are the same way. In order to support their growth needs they need adequate financial capital, capable employees, ample office space, and a variety of other corporate resources. A shortage of any one of these resources can severely restrict the growth aspirations of any business owner.

As a college sophomore I learned an important lesson about speed and taking care of my vehicle. I was on Thanksgiving break and was racing to get to Florida. In between Tallahassee and Ocala on I-10 my temperature light went on and I ignored it assuming it was some type of electrical malfunction.  Finally I stopped and just refilled my radiator with water. Shortly after getting back on the road, the car severely overheated and I ended up doing irreparable damage to the engine which than had to be replaced. This was a very costly mistake. How do you gauge whether your business engine is overheated or not?

  • External factors. I do drive slower in the rain. I also slow down in heavy traffic. The road leading out our sub-division has speed bumps so I am forced to alter my driving as a result of those impediments as well. There are certain market conditions that will cause business owners to slow down their growth rates as well. A lagging economy or rising interest rates will curb growth. Stiff competition might alter growth plans. Government policies on trade or taxes might also impede corporate growth.

So what is a safe growth rate for a small business? If you assume that safety and risk are related, then a safe growth rate might be one that does cause undue risk to the business entity. Typically in business we evaluate risk in terms of the amount of debt or liabilities the firm has. Hence a safe growth rate is one that does not cause the firm to add undue risk or debt to its balance sheet.

Here is a formula for calculating a sustainable growth rate that takes this into consideration:

Formula: (Net Profit%) X (1 + Debt/Equity)   (Var. Assets%) – [NPM%) x (1 + Debt/Equity)]

Let’s assume the following: a firm has a 10% net profit margin, a debt to equity ratio of 50%, and a ratio of variable assets to total assets of 75%. What is their sustainable growth rate (SGR)?

SGR = (.10) x (1 + .5)
——————–
(.75) – (.10) x (1 +.5)
= .15   =  .25 or 25%
—-
.6

In this example, the firm can safely grow revenues at a rate up to 25% without assuming any additional relative debt (risk). If the firm wants to grow at a faster pace, it would have to increase its debt/equity ratio thus increasing its risk factor. In addition, the business owner can also increase their sustainable growth rate by either improving their net profit margin or decreasing its use of variable assets as a percentage of total assets.

Using this equation, what is your company’s sustainable growth rate?

In the last ten years I have been in three auto accidents. In each case the other driver was at fault. Nevertheless I find myself driving slower these days. Why take a chance with #4? I suggest you do the same with your business. Watch the speed limit…