In the pursuit of improved profitability you might be forgiven for thinking that any kind of growth is desirable, but in reality there are two types of growth – healthy growth and unhealthy growth.
You can tell whether your growth is healthy or not by looking at your profit and loss statement or at your balance sheet.
From your profit and loss statement, calculate the percentage growth of sales and the percentage growth of earnings. If sales are growing faster than earnings, this is a sign of unhealthy growth. The bigger the gap, the more unhealthy the growth.
Alternatively, from your balance sheet, calculate the percentage growth of key asset categories – debtors, stock, and fixed assets such as equipment. If the percentage growth of these categories combined exceeds the percentage growth of sales, this is an indicator of unhealthy growth. Again, the bigger the gap, the more unhealthy the growth.
The indicators of healthy long-term growth are:
- The percentage growth in earnings is keeping up with or exceeding the percentage growth in sales
- The combined percentage increase in the key asset categories is less than the percentage increase in sales
Growth in sales can look impressive but if it is not matched by a corresponding increase in profitability it can conceal underlying problems such as:
- Inadequate cash flow
- Unhealthy stock levels
- Too many debtors
Sooner or later, these problems will surface as dissatisfied customers, demoralised employees, strained systems and controls, and stressed-out owners.
If the root causes are not addressed, what started out simply as a problem of rate of growth can become a question of survival.