Knowing what the key KPIs for scale-ups are, is a must if you’re a founder targeting exponential growth. With this information at your fingertips, you’ll be better equipped to move the dial on your business growth and innovation with ease. And you’ll be better placed to avoid the all-too common perils of the scale-up journey, such as growing too fast and too soon or missing a window of opportunity entirely. Once your start-up begins to scale, most of the tips and calculations we featured in our article, Nine essential calculations for start-ups to succeed, still hold true. But scaling up entails some unique challenges. So this article aims to take you through the metrics you’ll need for scale-up success.
Cash is king
The scale-up journey can end in tears. If you scale-up too fast, even a successful business with growing revenue and profits can fail because cash is king, when it comes to scaling up. There are three sources of capital that can provide the cash start-ups looking to scale, and scale-ups growing at pace, need. These are equity, debt and self-financeable growth.
Equity
Equity is capital you receive in exchange for a share of your business. It’s hard for start-ups and scale-ups to attract investor backing, but when they do, it’s usually obtained from Business Angels or Venture Capitalists. If your business fails, you don’t have to pay it back. But for that very reason, equity usually comes with a few strings attached. When investors back your venture, it often involves them taking control, or driving the direction, of your business. That’s how they protect their investment and mitigate the risk to their capital.
Dilution dilemma
There’s always a danger of becoming too diluted when you exchange equity for funding. Not only can you lose control of your business, but you can also effectively end up signing away the future returns on the business you’ve worked so hard to build. Although equity is essentially ‘free’ when you receive it because you don’t need to pay a deposit or interest, ultimately, it’s the most expensive form of capital for your business. For all those reasons, most experts agree that, as a founder, you should aim to keep at least 15%-25% or more of your business.[1] Use the formula below to calculate how diluted your venture is:
Dilution calculation formula: Existing Shares – New Shares/Existing Shares x 100 = dilution percentage [2]
Debt
Debt is capital you borrow and repay to the lender with interest. There are different types of debt, for example unsecured loans and secured loans that require collateral such as assets or future cash income.
Loan approval
For start-ups and scale-ups, debt financing is consistently tricky for innovation businesses to access from traditional lenders, such as banks. That’s why many start-ups and scale-ups claiming the R&D Tax Incentive (R&DTI) refund access it early with Radium Advances. When considering taking on debt, keep in mind that too much debt can negatively impact your cash flow and your ability to grow quickly. So using this handy formula will help you work out if your company is too highly geared and is being held back by carrying too much debt.
Debt-equity Ratio: Total Debt ÷ Total Equity = Debt-equity Ratio
In a nutshell, the higher your debt-equity ratio, the more dependent on debt and vulnerable to external shocks your business is. However, it’s important to remember that debt-equity ratios vary between sectors, so benchmark your business against your industry sector standard.
Self-financeable growth
Self-financeable growth (SFG) describes the amount of growth a scale-up can achieve by generating revenue without accessing capital from investors or financiers.[3] Building your start-up from the ground up is one thing. Scaling it is a whole different ball game in terms of the working capital, facilities, equipment and operating expenses your venture will require. Avoid the mistake of counting on investors or financiers to bankroll your growth. Over reliance on the former could leave you having to accept crumbs from the table when you exit, while over reliance on the latter could stymie your ability to grow. That’s where SFG comes in, and why it’s so important to know your maximum SFG rate.
What is a scale-up’s SFG rate?
If you’re sitting pretty and thinking the SFG rate isn’t relevant to your scale-up, think again. Even the most profitable scale-ups with great revenue streams can go belly up, if they don’t strike the right balance between consuming cash and generating it. A scale-up’s maximum SFG rate is the growth rate your scale-up can currently sustain. It’s a useful metric because it identifies when your scale-up would either have to adjust its operations or find new funding to support its growth and maintain a healthy cash flow. The SFG rate is determined by three key factors that you can use to help calculate your scale-up’s maximum SFG rate, they are:
- Your scale-up’s operating cash cycle
- The amount of cash that your scale up needs in order to fund every dollar of sales, including operating expenses and working capital.
- The amount of cash generated by each dollar of sales [4]
How to calculate your maximum SFG rate
When most companies are chugging along, not growing exponentially, their operations use the lion’s share of their income. But this doesn’t hold true for scale ups. High growth equates to a high demand for capital, so scale-ups need more cash flowing in. So, if a scale-up tries to grow too fast, it’s at risk of chewing through more cash than it can generate. If the business can’t source capital elsewhere, it could go under despite its success and in-demand offerings.
Follow these steps to find your scale-up’s maximum SFG rate. [5]
Step 1: Calculate your scale-up’s total operating cycle
Your scale-up’s total operating cycle refers to the time between your business purchasing inventory and your company receiving payment for the goods or services it sells. You can calculate it using this formula.
Inventory Days + Accounts Receivable days = Total Operating Cycle
Inventory days are the number of days it takes your scale-up to purchase raw materials, work on the product or service and sell the finished product or service to the customer.
The accounts receivable days refer to the number of days between the sale of the product or service and obtaining payment from the customer.
Step 2: Calculate your scale-up’s operating cash cycle
Accounts payable is the amount of money your scale-up owes your suppliers. Most supplier products and services are provided on a credit basis. So, your scale-up has a certain number of days to pay supplier invoices. The credit period can typically vary from seven to 60 days, depending on the supplier and your industry sector.
Total Operating Cycle – Accounts Payable = Operating Cash Cycle
By deducting your total operating cycle from your accounts payable you arrive at your scale-up’s operating cash cycle.
Step 3: Calculate your scale-up’s cash required per cycle
To calculate how much cash your scale-up needs per cycle, use the following formula:
Trade Payable ÷ Operating Cycle × Operating Cash Cycle = Cash Required
Trade payable refers to the amount your start-up has been billed by its suppliers for the goods and services your company purchases.
Step 4: Calculate your scale-up’s cash profit per cycle
Now, you’ll be able to calculate the amount of cash profit your scale-up is making per cycle, using the following formula:
Operating Profit After Tax ÷ (365 ÷ Total Operating Cycle) = Profit
Step 5: Calculate your scale-up’s self-financing growth rate per cycle [6]
Using information from the previous calculation, use this formula to calculate your scale-up’s SFG rate:
Profit ÷ Operating Cash Cycle = SFG rate
Step 6: Calculate your scale-up’s self-financing growth rate per year
Armed with your SFG rate, you can divide the number of days in a year by your Operating Cash Cycle to arrive at your SFG rate for the year.
365 ÷ Operating Cash Cycle × SFG rate = Annual SFG rate
Remember, your SFG rate is a crucial KPI to keep in mind. It’s the level of growth your scale-up can achieve independently, without requiring capital from investors or financiers, and it varies depending on your business and circumstances. So there’s no set SFG rate a business must meet.
Now you’re armed with your SFG rate, let’s look at the ways you can improve it.
Increase your Cash Conversion Cycle
The cash conversion cycle (CCC) is a metric that describes the number of days that it takes for your scale-up to convert resources, such as inventory into cash flows from sales. It can be broken down into three key areas: the sales cycle, the delivery cycle and the billing and payment cycle. It’s an important KPI to track if you want or need your scale-up to increase its SFG rate. If you can speed up any, or ideally all three areas of the CCC, you’ll increase the rate at which cash becomes available for your scale up. Bringing efficiencies into the sales and delivery process and adjusting your payment terms are ways you can accelerate the volume of cash flowing into your scale-up.
Reducing costs
Another way to increase your SFG rate is by reducing costs. Reducing the amount of capital your scale up needs to invest per cycle to deliver its products and services means your business has more cash available each cycle to invest in growth. The cost of goods sold (COGS) is a crucial KPI to track when you’re looking to reduce costs and free up more cash for scaling. Use this formula to calculate COGS for your scale-up: [7]
Beginning Inventory + Purchases during the Period – Ending Inventory = Cost of Goods Sold
The customer acquisition cost (CAC) reveals the cost to your business of acquiring a new customer. And it can help you pinpoint the most efficient use of your scale-up’s sales and marketing resources and budget. You can use CAC to understand the value to your company from each customer, improve your scale-up’s profit margins and ultimately free up additional cash for growth. Calculate CAC with this formula: [8]
Sales and Marketing Expense ÷ Number of New Customers = Customer Acquisition Cost
Raising prices
Ultimately, if the market will bear it, raising your prices is another lever you can pull to increase your maximum SFG rate.
Leverage cash and capital to grow your scale-up
Equity tends to be the go-to for scale-ups looking to fund their exponential growth. While investor capital plays a vital role, it’s crucial for start-ups to avoid becoming overly diluted and ensure they explore other sources of cash. Some scale-ups forget that if they’re investing in R&D they may be eligible to claim the R&DTI refund and access it early with R&D financing. Other high-growth ventures can underestimate how much they can finance their growth through revenue, profits and carefully managing their cash position. If you take a balanced approach to funding and control your cash position, there’s every chance you can scale your venture successfully without too many sleepless nights.
[1] https://www.investopedia.com. 2022. Diluted Founders. [ONLINE] Available at: https://www.investopedia.com/terms/d/dilutedfounders.asp
[2] Wall Street Mojo. 2023. https://www.wallstreetmojo.com/equity-dilution/. [ONLINE] Available at: https://www.wallstreetmojo.com.
[3] Harvard Business Review. (2001). How Fast Can Your Company Afford to Grow? [online] Available at: https://hbr.org/2001/05/how-fast-can-your-company-afford-to-grow.
[4] Harvard Business Review. (2001). How Fast Can Your Company Afford to Grow? [online] Available at: https://hbr.org/2001/05/how-fast-can-your-company-afford-to-grow.
[5] MANI (2021). Self-financeable Growth (SFG) – How Fast A Company Can Grow On Its Own? [online] GETMONEYRICH. Available at: https://getmoneyrich.com/self-financeable-growth-sfg/ [Accessed 9 Nov. 2023].
[6] Marks, K.H., Robbins, L.E., Fernández, G., Funkhouser, J.P. and Williams, D.L. (2009). Appendix D: How Fast Can Your Company Afford to Grow? pp.567–582. doi: https://doi.org/10.1002/9781118267691.app4.
[7] FERNANDO, J. (2023). Understanding Cost of Goods Sold – COGS. [online] Investopedia. Available at: https://www.investopedia.com/terms/c/cogs.asp.
[8] Corporate Finance Institute (n.d.). Customer Acquisition Cost (CAC). [online] Corporate Finance Institute. Available at: https://corporatefinanceinstitute.com/resources/accounting/customer-acquisition-cost-cac/.