The Short Answer

How Do You Know If Your Business Can Afford to Grow?

Textbook Definition

The growth cash gap is the cash a business must spend on equipment, people, and supplies before new work starts paying. Payback period is the investment divided by the cash it returns each year: the profit it adds plus its depreciation.

In Plain English

Before you grow, answer three questions. Does the new capacity earn more than the money costs to borrow? How much cash does it eat before the first customer pays? Where will that cash come from? If you cannot answer all three, wait.

Return on the Investment

Profit the growth adds ÷ what it costs

Proposed fourth crew: about 3% vs. an 8% loan

Payback Period

Cost ÷ (profit added + depreciation)

Proposed fourth crew: about 4.3 years

Show the Math

How $85,000 of Profit Left Ridgeline Deeper in the Hole

Ridgeline Landscaping closed Year 5 at $1.2 million of revenue and $85,000 of profit. Here is the bridge from profit to cash, the same tool from what is cash flow.

Year 5: profit to cashAmount
Cash at the start of Year 5$26,500
Plus: net profit$85,000
Plus: depreciation$55,000
Less: customers owe more($50,000)
Plus: owes suppliers more$8,000
Less: equipment bought($115,000)
Plus: new equipment loans$80,000
Less: loan principal paid($55,000)
Plus: line of credit drawn$40,000
Less: distributions to the owner($52,500)
Cash at the end of Year 5$22,000

Fictional figures from the book.

Subtract the Line of Credit End of Year 4: $26,500 cash − $20,000 line = $6,500 End of Year 5: $22,000 cash − $60,000 line = −$38,000 Change on its own cash: $6,500 → −$38,000 = $44,500 worse The bank balance only dropped $4,500. It looked fine. It was not. The line of credit was covering the gap.

The Method

How to Decide on Growth in 5 Steps

  1. Build last year’s profit-to-cash bridge.

    Then subtract the line of credit from the bank balance. If profit rose while that number fell, stop and find out why.

  2. Check the three warning signs.

    Profit up and cash down. Receivables growing faster than sales: Ridgeline’s sales grew 14%, receivables 53%. A line of credit that only goes up.

  3. Price the expansion like an investment.

    The proposed fourth crew: $260,000 of revenue, $91,000 after job costs, minus $55,000 crew overhead, $25,000 depreciation, and $7,200 interest. Profit added: $3,800.

  4. Count the cash gap before the first check.

    $35,000 down payment, $36,000 of payroll, fuel, and materials for six weeks, and $9,000 of added overhead. About $80,000 before a dollar comes back.

  5. Run the four go/no-go rules.

    Fail one, fix it first, or grow in a smaller step.

The Four Go/No-Go Rules

1. Signed work for at least 60% of the new capacity. Contracts, not prospects. 2. The reserve is at target before growth starts. 3. The line of credit has been at zero for at least 30 days in the last year. 4. The return beats the loan rate by a wide margin, and debt service coverage stays above 1.5. Ridgeline had no signed work, a reserve below target, and a line that had not been to zero, and the crew’s return did not beat the rate either. Mike waited, took the one signed contract with the crews he had, and subcontracted the rest. Payback math for a single machine works the same way: see how to calculate break-even.

Diminishing Returns

Every Crew Ridgeline Added, Side by Side

CrewInvestmentReturnPayback
Crew 2 (Year 3)$110,000about 51%about 1.4 years
Crew 3 (Year 4)$147,500about 32%about 1.9 years
Crew 4 (proposed)$125,000about 3%about 4.3 years

Fictional figures from the book. The fourth crew returns about 3% on money that costs 8%.

Each crew returned less than the one before. The new work was bid against bigger companies, so it was priced lower, and four crews would need a real supervisor. The same thing happens to restaurants: a second location can be profitable on paper by month four and still run out of cash, because the build-out, staff, and opening inventory came first.

Owner Warning

What Does Growing Too Fast Look Like?

  • Believing the bank balance without subtracting the line of credit.
  • Hiring and buying for prospects instead of signed contracts.
  • Ignoring receivables that grow faster than sales.
  • Funding growth from the reserve.
  • Adding a crew that earns less than the loan costs.
  • Judging an expansion by revenue instead of return and payback.
Dale added a truck and two helpers for four customers he felt good about. Two signed. He ran out of cash in June, his busiest month ever. Chapter 19 walks through why.Get the Book on Amazon →

From the Book

Where the Money Went

Chapter 19 · What Growth Really Costs

The Year 5 Bridge

At the end of Year 4, cash minus the line was $6,500. At the end of Year 5, it was negative $38,000. Ridgeline made $85,000 of profit and went $44,500 deeper into the hole on its own cash.

The bridge, the three warning signs, the cash gap, the go/no-go rules, and what Mike did instead of building the fourth crew. Get the book.

Get the Book on Amazon →

Planning Your Next Expansion?

A crew, a truck line, a second location: the plan has to work on cash, not just on paper. Dr. Paul writes growth plans with full cash projections, the kind a lender reads before funding the next step. See business growth plan pricing or business plan writing services.

Beyond the Book

Ready to Run the Numbers for Real?

Learning the statements is step one. When it is your business on the line, start here.

Business Plan Templates

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Business Plan Writing

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Business Consulting

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FAQ

Growth and Cash Questions

Why does my business have less cash as it grows?
Because growth spends cash before it earns it. New equipment, new payroll, and more customers owing you money all come first. Profit can rise while cash falls, and a growing line of credit can hide the gap until it is too big to ignore.
What is a growth cash gap?
The cash you have to spend on new equipment, people, and supplies before the new work starts paying you. In the book’s example, a fourth landscaping crew needed about $80,000 before its first commercial customer paid.
How do I calculate the payback period on an expansion?
Divide what the expansion costs by the cash it brings back each year, which is the profit it adds plus its depreciation. A $125,000 crew that adds $3,800 of profit and $25,000 of depreciation pays back in about 4.3 years.
When is a small business ready to expand?
When it has signed work for most of the new capacity, a funded cash reserve, a line of credit that has been paid to zero recently, and an expansion return well above its borrowing rate. Miss one and fix it first.

Keep Going

Related Guides

From startup costs to the 13-week forecast: the full small business finance guide.

Guide 8 · Buy or Lease Equipment

Price the trucks and machines growth requires.

Guide 10 · 13-Week Cash Forecast

See the growth cash gap coming week by week.

Guide 5 · Customer Profitability

Make sure the new work is work worth having.
← Previous · Guide 8Should I Buy or Lease Equipment for My Business?

Written by Dr. Paul Borosky, DBA, MBA, business consultant, author, and adjunct finance instructor with an MBA focused in finance.

This page is for general educational purposes only. It is not legal, financial, tax, accounting, or lending advice. Tax rules change by place and by year. Ridgeline Landscaping and its figures are a fictional illustration from the book, not a projection for your business. For decisions about your own business, consult a qualified professional.