Key takeaways
- A growth trap occurs when sales grow faster than the company's ability to find the cash to support working capital and investment
- Working capital has to be funded before profit comes in, so a profitable company can run out of cash in its best sales year
- In the example, if NWC is 25% of sales and net profit is 8%, the company can grow with its own cash by no more than about 47% a year, before CAPEX and dividends
This year a major customer gave a strong signal. Sales jumped and the team celebrated, but the owner could not sleep. More raw materials had to be ordered, more people hired, the warehouse expanded, and customers given longer credit. Everything has to be paid for before cash from the new sales arrives. The more the business grows, the harder it works and the less cash it has, like a child who grows fast and needs to eat more and change clothes straight away, before the body is strong enough to keep up.
Why growth consumes cash
Every baht added to sales usually means more cash tied up immediately in receivables and inventory, less the extra credit that suppliers give. If customers pay in 60 days but wages and raw materials must be paid within 30 days, the company has to fund the gap from the first day it takes on the work. There are also step costs, such as new staff, machinery, space and systems, which must be paid for before the new sales justify them.
The growth rate your own cash can support
Assuming NWC is a constant proportion of sales and all profit is retained in the company, the maximum growth rate at which profit can pay for the increase in NWC is given by this formula
Maximum g = Net Margin ÷ (NWC to sales - Net Margin)
This formula does not tell you how much you should grow. It tells you the starting point: beyond it, the company needs outside funding or must fix its working capital
Example: doubling sales
Assume sales of THB 100 million, NWC of 25% of sales (roughly equivalent to about 91 days of sales tied up), and a net margin of 8%
| Next year (THB million) | Growth of 100% | Growth of 47% |
|---|---|---|
| Sales | 200.0 | 147.0 |
| NWC required | 50.0 | 36.75 |
| Increase in NWC from 25 | 25.0 | 11.75 |
| Net profit at 8% | 16.0 | 11.76 |
| Cash shortfall (surplus) | 9.0 | (0.01) |
If sales double, the company is short of THB 9 million before counting CAPEX and principal repayments. If a further THB 10 million of investment is needed, the shortfall becomes THB 19 million. In practice, NWC has to be paid for before profit comes in, so the lowest cash point during the year may be deeper than the year-end figure.
Fixing either of the two variables gives a similar result. If NWC is reduced to 20% of sales, maximum g becomes 8 ÷ (20 - 8) = 66.7%. If net margin rises to 10% while NWC stays the same, the result is 10 ÷ (25 - 10) = 66.7% as well.
The real risk is not borrowing itself, but borrowing short-term to pay for long-term investment, or starting to expand without a facility in place. Growth should be funded from sources whose tenor matches the time it takes for the cash to come back.
Options when the numbers show a cash shortfall
| Option | Suitable when | Points to watch |
|---|---|---|
| Reduce the CCC before expanding | Receivables or inventory that can be managed | Must not damage customer or supplier relationships |
| Ask for deposits or staged payments | Specialised work or large contracts | Terms may have to be traded off against price |
| Revolving credit facility | Good-quality receivables | Cost of funds and rolling over debt |
| Phased Expansion | Need to prove genuine demand | May lose some opportunities |
| Raise equity | Growth beyond what debt can support | Existing owners are diluted |
| Decline or limit some work | Low-margin work that consumes a lot of cash | Choose using the numbers, not emotion |
In property development, a growth trap often appears as starting the next project before the first has finished transferring. Cash from the old project is pulled into buying new land while the old project's construction costs and taxes are still waiting to be paid.
Checking readiness before taking on growth
Before taking on a large job, ask the job itself some direct questions. What is the peak cash it will tie up, and when? Will the customer pay on the actual terms? If payment is 30 days later, does the company still have enough cash? And is the job still worthwhile after deducting the cost of funds and the additional expenses? Some jobs show a profit on the quotation, but once interest and single-customer risk are counted, they should not be accepted in their original form.
Good growth is therefore not measured by the growth rate alone. Look at it together with operating cash flow, gross margin and debt to EBITDA. If sales grow while these three worsen over several consecutive periods, the company is buying growth with its own balance sheet.
Next steps
- Calculate NWC to sales and net margin from the latest financial statements
- Find the maximum g and compare it with next year's growth plan
- Prepare a monthly cash plan for the year of growth to find the lowest point, not just the year-end figure
- Separate the funds required into working capital, CAPEX and hiring
- Arrange the facility before taking on the large job, not after cash starts to tighten
- Set phased expansion conditions: if results fall short of target, stop before moving to the next phase
- Assess major customers before extending more credit, looking at the effect on both profit and cash