Growth and profitability are two sides of the same coin but whether you focus on growth or profitability, you must know how and when to build each element into the culture and operations of the company. The burning question every business owner ought to answer is, where you fall on the growth vs. profitability spectrum? Of course, many CEOs will push for growth at all costs because high growth companies are usually more valuable than slower growing companies within the same industry. However, if profit margin spirals down as revenue grows, the business owner may be driving the company towards a death-by-growth end.
Here are key tips to help you effectively balance growth and profit:
To understand where you stand on the spectrum, it is pertinent to go back to the drawing board and review the goals of the company. Is the goal to maximize revenue or hit a certain level of profitability? Or is it a bit of both? Different CEOs will react differently and have varying answers to this question. For private owned companies funded by investors, maximizing cash flow and profits may be an overwhelming target. So, if you are focused on growth and are operating at a loss, you should have a clear plan and potential timeline for increasing your profit margin. Whereas for public companies, they will be focused on maximizing the share price, which is trying to ensure the company, is effectively balancing on both sides against other competitors in the same industry.
Explore “Rule 45”
According to an experienced Wall Street banker, for a company to achieve an exceptional valuation in the market, its annual growth rate plus its operating margin needed to exceed 45 per cent. Although this is just a rule of thumb, it will amaze you how effective this rule may be with regards to balancing growth and profitability. On the north pole of the rule, you can break even or actually operate at a loss and still be rewarded in the market.
While on the flip side, if a company is not growing or is experiencing slow growth, it needs an operating margin north of 45 per cent to achieve a high valuation. High operating margins are very tough to reach and even tougher to maintain over time. This is just a supporting point for the idea that companies cannot be stuck for very long and remain valuable or relevant. Employ the Rule of 45 as a simple way to serve as a benchmark for your business against the best players in the industry. If you are aiming for a certain growth rate, consider how that might affect your operating margin. If you are striving for a certain level of profitability, consider how that might affect your capacity to grow.
If your aim is growth, you must be willing to invest in new ideas, products, and resources in order to maximize productivity. You should also balance those investments against the long-term plan for profit. The most successful businesses would have a high level of profitability while also growing exponentially. While a combination of these two is almost impossible, finding the right balance results to leading your company to success.
If you found this article useful, bookmark 234Finance.com or kindly follow all of our social media pages for more business tips.
234Finance.com is an online platform that promotes African entrepreneurship. We achieve this by bridging the gap between investors and early stage startups in Africa’s emerging market.
234Finance.com is strategic for promoting entrepreneurship through the power and effective use of information.