This is a true story, although the names and places have been changed. Everything ended up OK, but there was a lot of unnecessary stress--all of which could have been easily prevented by just a minimum of business planning. This kind of problem happens all the time, and it's so easily preventable, it's a shame it happens at all. The lesson: Don't be a victim of unplanned growth.
The story takes place in a midsize university town on the West Coast, during the mid '90s, as the internet boom took off and most everybody in business and education was getting connected. The main players are Leslie and Terry, co-owners of a consulting business offering computer and network services mostly to local businesses.
At the beginning of this story, Leslie and Terry had a small but comfortable office a few blocks off Main Street, near the university, and a comfortable business, averaging about $20,000 in sales per month with a few steady clients and not a lot of seasonal variations in sales. They had one employee who did the bookkeeping and general administration tasks, maintained office hours and made appointments.
Then came the big, wonderful new job--a contract with a large and fast-growing company to install new internet facilities in offices on its corporate campus, 10 miles up the freeway. This was a $200,000 contract that had to be delivered quickly and opened up an important new relationship with a potential business-changing client. There was great celebration. Leslie and Terry and their spouses started with a fancy dinner in the best restaurant in the area.
Both partners readily got going on fulfilling the contract, delivering the network, connecting the systems, making good on their promises. To make sure the new relationship would be a permanent increase in business, they took on five contractor consultants to deal with the needs of installation, training and the general increase in business demands.
Within two months, it seemed clear to both partners that they'd made the leap. Systems were being installed, clients were happy, and they were on the road to doubling their business volume in a very short period of time. The contractors were doing good work, and four of the five were happy to consider becoming permanent employees. Leslie and Terry decided they could celebrate more, so they both went to the local car dealer and leased new Mercedes sedans.
Then things started going bad. Like a television loosing its connection, things got fuzzy, then blank. Though sales and profits were way up, jobs were done and invoicing was underway, Leslie and Terry had no money. The contractors--good people who Leslie and Terry wanted to keep--needed to be paid, but there was no money. They rushed to their local bank, waving their increased sales and profits, but banks need time. The business suffered the classic problems of unplanned growth. Just as the accounting reports looked brightest, the coffers were empty. People were barely done celebrating, and suddenly they were looking at the disaster of unpaid bills and, much worse, unpaid people.
What happened? Unplanned cash flow problems happened. The new, larger client had a slow process when it came to paying bills, so the jump in sales didn't mean an immediate jump in cash in the bank. Leslie and Terry were more concerned about delivering good service than delivering necessary paperwork, so their own invoicing process was slow. They were owed about $85,000, but they couldn't go straight to their new client to get the money--she said she'd already authorized payment and sent them to the company's finance department for answers. The people in the finance department were slow to respond and not particularly concerned about vendors getting paid quickly; their job was to pay slowly, but not so slowly as to get a bad credit rating.
Leslie and Terry had a bad case of "receivables starvation"--money that was owed to them was already showing in sales and profits, but not in the bank. It would have been predictable, and preventable, with a good plan.
In this case, fortunately, the two partners had enough house equity to get a quick loan and pay their contractors. The business was saved and grew, but not without a great deal of stress and strain, and even second mortgages.
The worst moment is worth remembering: One of the partners' spouses was particularly eloquent about the irony of taking on a new mortgage while driving that "[profanity omitted] Mercedes."
The moral of the story: Always have a good cash flow plan. Never get caught not knowing the impact of a sudden rush of new business. Get to the bank early, as soon as you know about new business, and start processing a credit line on receivables. And never lease a Mercedes until you're sure you won't have to take out a new mortgage a few weeks later.