In today’s hyper-fast business world, we watch startups like Uber and AirBnB go from zero to billions seemingly overnight.
It’s tempting to measure yourself by these examples and to feel wholly inadequate. Personally, I have to wonder: Why aren’t my businesses growing as fast as these new-age juggernauts? What am I doing wrong? Is hyper-growth the new “normal”?
The truth is, Uber-style growth is neither normal nor sustainable, and no “normal” company should worry about emulating it. The reason for this is two-fold:
- Without VC money to flush down the toilet, you must fund you own growth
- Your funding is mathematically limited by actual profits.
Let’s take a closer look at this simple logic.
Normal companies are funded by profits, not Venture Capitalists (VC). Groupon, meanwhile, has burned through almost a billion dollars of venture capital.
Profitable companies have limits…
Believe it or not, growth is naturally limited in a company that is not venture-funded. Big companies figured this out decades ago. In fact, Hewlett Packard pioneered the term “Affordable Growth Rate” to describe the maximum speed of growth at HP in the 1950s.
HP’s Affordable Growth Rate formula is a good (and easy to calculate) benchmark for forecasting and budgeting your own growth.
Your Affordable Growth Rate (AGR) is the percentage that your sales can grow year over year fueled only by profits. If your sales doubled, that’s 100 percent growth – that much is simple. But sales growth is limited by your ability to fund new sales… which is limited by profits. Get it?
So — how fast can your business grow? Calculate your maximum AGR by dividing this year’s net profits by last year’s equity.
More specifically your Affordable Growth Rate (AGR) is equal to:
[(this year’s after tax retained profits) / (Stockholders’ tangible equity at the end of last year)]
Hewlett Packard used this equation to limit its own growth. Yes, that’s right, they wanted to limit growth.
Why? Because growing sales faster than the rest of your business is a sure way to get yourself into financial trouble. HP knew that sales have to be financed (computers have to be built, sales people paid, etc.), and financing comes either from your own assets (cash) or what you can borrow against those assets (loans).
Good Growth is Sustainable
There’s no such thing as unlimited growth in a normal company. In fact, just the opposite. Your AGR is a rather good formula to show why growth should be limited. You can only grow as fast as your profits (and equity growth) allow.
Not even Uber can change the fundamentals of sustainable growth.
So whether you make lunch boxes or machine tools, websites or weed-whackers, take note. Make your best effort to grow – just be sure that the growth is sustainable by sticking to your AGR limits.
Dedicated to your (Growing!) profits,
PS: Growing too fast is the primary cause of bad cash flow. Want to calculate how much cash your business needs to stay afloat? Try this blog about Cash Flow Forecasting