Lifecycle of a Business
From the day it is born until the day of its death, a business tells a story. A story understood from its Financial Statements. To comprehend it, you need to speak its language: Accounting.
This is the story of a business from its Start-up phase to its declining one.
Let us assume that as Entrepreneurs we recently started a business. The business is manufacturing a new generation of bicycle that we’ll call the BuzoBike. Being just a startup, our profits are negative. We are producing goods for more cost than income received. This is because the volume is still too low and economy of scale does not exist yet. We need to invest in machinery and our workforce is still learning to be efficient. We also need to build some inventory and provide credit to our customers. Unfortunately, because this is still a young business, our suppliers are not providing us with credit. We use cash to buy raw material, build inventory, buy the machines, pay employees, package the goods and smile. While on the other hand, getting few credit from our suppliers and having very few sales. Life is tough!
– Losses are huge
– Business has no debt and pays no interest
– Working Capital and Fixed Capital are big expenses as we build the business
– No taxes paid, as the business does not have profit
– Business receives grant from government because it is creating jobs
The Growth Phase:
The business survived the initial and toughest phase and is now growing.
(Wish all my Entrepreneur friends to get there as fast as possible)
Our business is now generating a profit, as the revenues from its sales are higher than its costs. However we are still investing in net working capital, thus building our inventory and debtors. Unlike the start up phase, we are now able to obtain credit from our suppliers due to our 3 years track record. Moreover, due to our continuous growth and growing needs, we continue to invest in fixed assets. Leasing companies are now lending us money as they have machinery and plant as collateral. Investors are prepared to invest in our business if they believe future cash flow is worth it.
Grants from the government are still being provided as we are increasing our workforce. However, overall the cash flow is still negative because a big part of profits, debt and equity issued goes into Fixed Asset investments, Working capital and Marketing.
– Cash revenues are higher than cash costs
– Taxes are very small due in part to the tax depreciation from fixed investments in machinery
– Pay little interest on our small debt
– Still investing in Working capital and Fixed investments
– Overall cash flow is negative
The Mature Phase:
The mature phase is attained when few investments in Working capital and Fixed investment are required. Also as a mature business the overall cash flow is positive. The BuzoBike is of such high quality and our customer service is so good that few competitors want to face us in our market. We manufacture bicycles that last 15 years with few repairs required and that few can replicate.
The business is generating a healthy cash surplus against the costs. We have thousands of customers all over the world. And the volume of production is growing slowly but surely. Investment in net working capital and fixed investments is minimal. No need to build new plants. We only need to replace old computers, trucks, machines…
As there is little fixed investments, tax depreciation is very low and therefore taxes paid are very high. Finally, due to economy of scale we are able to pay for working capital, fixed investments, interest on debt, even provide dividends and still have positive cash flow.
– We enjoy Economy of scale and huge revenues
– Small need for net working capital and fixed investments
– Debt can grow and offer tax shelter opportunities
– We can pay a dividend to shareholders
– Overall cash flow is positive
The Decline Phase:
A Korean firm came up with a new type of bicycle that can fly and is easy to handle. Our sales are decreasing year after year and the BuzoBike is being forgotten. We tried to innovate by implementing cool perks on our new models but the market was unresponsive.
The business is losing money fast. No need to invest in inventory, working capital or fixed investment anymore. On the contrary, we are now selling the factories that are not needed, firing employees and reducing the dividend. Taxes and interest paid are still very high. Ultimately, our customers, investors and even employees will leave us and the business will be liquidated.
– Sales are plummeting every year
– We are selling our Net Working Capital and fixed capital investments
– Fixed costs are still high even though sales are decreasing
– We are surviving by selling assets and not by growing revenues
– Liquidation is on the horizon
This was the exciting and interesting life of our business. Surely, no two businesses are alike but understanding the general cycle of a business through its accounting is essential for many.
PS: My friend Carla is a great entrepreneur and manufactures/sells an amazing Swiss revolutionary skin care cream called “La Peau”.
Check it out: http://www.lapeauskincare.com/