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Sales Growth Rates

November 8, 2007

Do not be desirous of having things done quickly. Do not look at small advantages. Desire to have things done quickly prevents their being done thoroughly. Looking at small advantages prevents great affairs from being accomplished. ~Confucius

Frequently, entrepreneurs prepare a sales forecast in order to generate a forecasted income statement and balance sheet. Normally, these forecasts utilize percentage sales increases that are assumed to be rigid. I regularly hear statements like, “We want to grow 20% this year,” or, “Our target growth rate this year is 30%.” Entrepreneurs should be cautious, however, as this process is fraught with problems and some danger spots.

While it is great to pursue sales growth, it must be tempered by the resources that are available to support sales activities. It takes many different resources to produce sales, and forecasting sales without taking these into account could put the firm in a precarious position.

We were working with a firm that wanted to grow sales to $5 million in 5 years. In order to hit this goal, they would have to grow at a rate of 20% per year. While this sounded like a reasonable goal, it turned out to be impossible to achieve.

In order to expand sales by 20% a year, the firm would have to triple the size of its staff. Since the firm was already struggling to find workers, tripling their work force would prove just about impossible. Once they built reasonable assumptions about staff into their forecast, they found that they could only grow at a rate of 5%.

Another firm, having achieved sales growth rates of 20% for the last two years, wanted to grow sales by 30%. They had a sufficient labor force to make it work, but since they were unable to secure more equity, they would have to finance the necessary funding using debt. Yet, if the firm was to finance their additional sales with debt, they would hit their debt capacity in 3 years.

In order to reach the forecasted 30% sales growth, the firm’s percentage of debt would increase to 70%, surpassing the bank stipulation that 40% of their assets be funded with equity and 60% with debt. Once the firm assumed that it could not have more than 60% debt, they found that the maximum annual growth they could support was 12%.

To ascertain if a sales growth rate is viable, generate a forecasted income statement and balance sheet, and evaluate each element to see if the numbers are achievable. Say, for example, that this pro forma statement shows an inventory in year 2 of $500,000. You know, however, that there is no way for you to produce this level of inventory because of an uncorrectable defect in the production process. As a solution, simply input an inventory number that is viable and let this number determine the sales growth rate and sales levels. This method allows the limiting factors of running a business to determine the sales growth rate. By letting resources determine sales growth rates, you make your forecasts achievable.

Now go out and make sure that you have the necessary resources in place to make your forecasted growth rate viable.

You can do this!