Should I chase growth or profit?

By Lance O'Grady

If you’re starting a business, there’s always a conundrum that follows. Do you grow your company as fast as you can by acquiring customers, or do you focus on breaking even first and making a profit, or neither?

There’s a great business saying which can be very focusing for business owners. It goes like this:

Revenue is vanity. Profit is sanity. 

I wholeheartedly endorse that, but I admonish you to consider this important addendum:

Cash flow is reality.

Generally there are 3 business models that anyone starting up in business should have in mind.

1)    Sole proprietor. The owner does all of the work. Overheads are very low so the owner keeps most of the profit.

2)    Small, boutique business. Often these emerge from a startup. The owner gets frustrated doing everything so he or she hires a small team — perhaps a salesperson or someone to look after the finances and administration.

3)    A larger business. Remembering that a big business is nothing more than a small business that did the right things right, the owner systematically and progressively grows the business by hiring a team of people, creating new products and/or services and considering new locations.

So which is the right approach? Well, it depends. What’s right for one person may be totally unpalatable for someone else in exactly the same industry. To determine the most appropriate approach for you, start with your objectives. Why are you considering starting your own business?

So back to the question: growth or profit? Growth relates to top line — revenue. Profit relates to bottom line — what is left over after you have paid all of your expenses. Let’s look at a simple case study to make some informed judgements on this.

Jenny decided to start her own business offering hairdressing and beauty services. She was well known in her local area, great with her customers, and enlisted the help of her brother, Mike, who brought marketing skills to the party.

In year 1, Jenny’s business looked like this:

Number of transactions 1,568
Average transaction value $58
Revenue $90,944
Gross profit % 85%
Gross profit $77,302
Overheads $15,000
Net profit $62,303

In year 2, Jenny decided she needed to attract more customers.

She figured that if she worked 50 weeks a year, 6 days a week, she could see 7 customers per day, so her capacity should be 2,100 transactions. She decided to discount her prices by 10% to attract more customers.

This was the result:

Number of transactions 1,814
Average transaction value $52
Revenue $94,328
Gross profit % 85%
Gross profit $80,178
Overheads $15,000
Net profit $65,178

By year 3, all seemed to be going well so Jenny decided to continue the push to fill up her capacity.She decided to offer customers a 14 day account, rather than asking for cash upfront. 50% of customers took her up on this offer.

 Her business in year 3 now looked like this:

 Number of transactions 2,018
Average transaction value $52
Revenue $104,936
Gross profit % 85%
Gross profit $89,195
Overheads $15,000
Net profit $74,196
Receivables at end of year $11,839

Here is the most important table of all:

  Year 1 Year 2 Year 3
Cash generated $62,303 $65,178 $62,357

In year 3, Jenny was working over 30% harder and generating the same cash as in her first year of trading. It doesn’t look good. She also found in year 4 that, because of her inability to enforce the 14 day terms, her receivables blew out even more. She had to hire a part-time person to take care of them, which incurred more cost. And because of her cash flow problems, she was unable to pay one of her key suppliers on time with the result being that the supplier shortened its own terms of trade, hurting Jenny’s cash flow even more.

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