How understanding the business life cycle helps in

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Understanding the

business life cycle and

the position of a

business in its cycle

helps us in assessing

the business and its

financial needs.

So, first off, let’s take a look at the

business life cycle and its various

phases.

So, first off, let’s take a look at the

business life cycle and its various

phases.

It’s the position of the business

in one of those phases that

determines its financial

needs and what type

of facilities can be

offered by the bank.

The concept behind the business life cycle

is that every business goes through

different phases during its lifetime.

That lifetime might last a few months or it

could last 100 or so years…….

…….but all businesses have to come

into existence, experience growth (fast or

slow), then reach a point where the

growth tails off and, eventually, they will

fall into decline if nothing changes within

the business to send it back into another

growth phase.

…….but all businesses have to come

into existence, experience growth (fast or

slow), then reach a point where the

growth tails off and, eventually, they will

fall into decline if nothing changes within

the business to send it back into another

growth phase.

Here’s what the cycle looks like……..

Business life cycle

Sales

Time

Start -

up

Growth

Maturity

Decline

The key thing to remember,

then, is that it’s the business’

sales figure that indicates in

which phase of the life cycle it’s

in.

The key thing to remember,

then, is that it’s the business’

sales figure that indicates in

which phase of the life cycle it’s

in.

So look at the trend in sales on

the income statement for the

past 3 or 4 years to get a sense

of where the business is now

and where it’s heading.

So, what’s happening to a

business as it moves

through each phase?

In the start-up phase, the business is

just getting going, trying to make some

sales but incurring expenses as it

establishes itself and acquires assets

and capacity.

In the growth phase, the business has

established itself in the market and

starts to generate significant sales that

take it into a profitable situation.

In the growth phase, the business has

established itself in the market and

starts to generate significant sales that

take it into a profitable situation.

The problem is that sales growth often

has to be supported by additional

inventories and/or accounts receivable

(depending on the type of business)

so more cash is tied-up in working

capital (current assets).

In the maturity phase, the business is

well established in the market and

sales are at a relatively high level

which generates significant profit.

In the decline phase, the business is

losing ground in its market which could

be due to a variety of reasons. Sales

fall and the business becomes

unprofitable.

In the decline phase, the business is

losing ground in its market which could

be due to a variety of reasons. Sales

fall and the business becomes

unprofitable.

There are two ways it will go – either it

will disappear entirely or it could revert

to a new growth phase if the cause of

its decline can be reversed – often

achieved with a change of

management.

Once you have an idea of which phase of

the life cycle the business is in, it’s useful

to think about the characteristics of a

typical business in the phase – that will

help you to focus on what the business

might now be looking like and what to

expect.

We’ll use four characteristics for this

purpose. For each phase we’ll think about a

typical business’;

Cash position

Profit

Capital base

Management experience

In the start-up phase, we’d typically expect to

see;

In the start-up phase, we’d typically expect to

see;

A weak cash position due to the need to

invest in assets and working capital to pay

operating expenses while sales (and,

therefore, income) are still low.

In the start-up phase, we’d typically expect to

see;

A weak cash position due to the need to

invest in assets and working capital to pay

operating expenses while sales (and,

therefore, income) are still low.

Weak profits because sales are still low and

are insufficient to cover operating expenses.

A weak capital base because start-up

businesses are usually under-capitalised from

the start and the capital base is not being

strengthened from profit retention because

there would usually be no profits at this time.

A weak capital base because start-up

businesses are usually under-capitalised from

the start and the capital base is not being

strengthened from profit retention because

there would usually be no profits at this time.

Weak management experience because the

managers are new to the role and need time

to gain experience.

Given all these weak

characteristics, it’s no

surprise that banks are

often reluctant to lend to

a business in the start-

up phase of its business

life cycle.

In the growth phase, we’d typically expect to

see;

In the growth phase, we’d typically expect to

see;

A weak cash position due to the need to

continue to invest in additional assets and

working capital to support the growth and to

pay ever-increasing operating expenses while

sales (and, therefore, income) are still

growing.

In the growth phase, we’d typically expect to

see;

A weak cash position due to the need to

continue to invest in additional assets and

working capital to support the growth and to

pay ever-increasing operating expenses while

sales (and, therefore, income) are still

growing.

Improving profits because sales are growing

and are covering operating expenses.

An improving capital base because it’s usual

for growing businesses to retain any profits

made and these are added to the capital

base in order to finance the growing asset

side of the balance sheet.

An improving capital base because it’s usual

for growing businesses to retain any profits

made and these are added to the capital

base in order to finance the growing asset

side of the balance sheet.

Improving management experience because

the managers are learning more about the

market as the business grows and they learn

more about their role.

Given these mostly

improving characteristics,

these businesses are

attractive targets for banks.

Given these mostly

improving characteristics,

these businesses are

attractive targets for banks.

The only problem is that

they are really only just

established in their

markets so the future

could go either way.

In the maturity phase, we’d typically expect to

see;

In the maturity phase, we’d typically expect to

see;

A good cash position as there is no longer a

need to continue to invest in additional assets

and working capital as the business is in a

maintenance phase where sales are at a

reasonably high level but are not growing.

In the maturity phase, we’d typically expect to

see;

A good cash position as there is no longer a

need to continue to invest in additional assets

and working capital as the business is in a

maintenance phase where sales are at a

reasonably high level but are not growing.

Good profits because sales are high and are

generating sufficient profits to cover operating

expenses which are well under control.

A good capital base because at least some of

the profits have been retained (after any

dividends were paid to shareholders) and the

profits have been added to the capital base.

A good capital base because at least some of

the profits have been retained (after any

dividends were paid to shareholders) and the

profits have been added to the capital base.

Good management experience because the

managers are fully conversant with the needs

of the market and their roles.

Given these strong

characteristics, these

businesses are highly

attractive targets for banks.

Given these strong

characteristics, these

businesses are highly

attractive targets for banks.

The only problem is that

the businesses don’t really

need banks any longer as

they have sufficient cash to

pay their expenses and

often finance their own

asset replacement policy.

In the decline phase, we’d typically expect to

see;

In the decline phase, we’d typically expect to

see;

A weakening cash position as sales are

falling and businesses are usually slow

and/or reluctant to reduce operating

expenses significantly – very often

management believes the decline to be

temporary.

In the decline phase, we’d typically expect to

see;

A weakening cash position as sales are

falling and businesses are usually slow

and/or reluctant to reduce operating

expenses significantly – very often

management believes the decline to be

temporary.

Reducing profits because sales are falling

and are failing to generate sufficient profit to

cover operating expenses.

A weakening capital base because profits are

reducing and shareholders are often reluctant

to give up their dividends leading to little profit

retention. Often, dividends are paid from

previous year profits, directly reducing the

capital base.

A weakening capital base because profits are

reducing and shareholders are often reluctant

to give up their dividends leading to little profit

retention. Often, dividends are paid from

previous year profits, directly reducing the

capital base.

Good management experience (assuming the

same management is in place) but often they

become distracted because the business

does not offer them the same stimulation as

when it was successful.

Given these weakening

characteristics, these

businesses are not targets

for banks.

Given these weakening

characteristics, these

businesses are not targets

for banks.

The only problem is that

the businesses already

hold accounts at banks so

banks cannot easily get rid

of them – but they should

try before its too late.

If we think about the types of borrowing

facilities that businesses in each phase might

need, we would have the following;

If we think about the types of borrowing

facilities that businesses in each phase might

need, we would have the following;

In the start-up phase, businesses need short-

term facilities to finance working capital such

as inventory, accounts receivable etc. and

term loans to finance fixed assets such as

vehicles, plant and equipment, buildings etc.

In the growth phase, businesses need short-

term facilities to finance increasing working

capital such as inventory, accounts

receivable etc. and term loans to finance

fixed assets such as vehicles, plant and

equipment, buildings etc.

In the maturity phase, businesses no longer

need short-term facilities to finance working

capital but they might require term loans to

finance the replacement of fixed assets such

as vehicles, plant and equipment, buildings

etc.

In the maturity phase, businesses no longer

need short-term facilities to finance working

capital but they might require term loans to

finance the replacement of fixed assets such

as vehicles, plant and equipment, buildings

etc.

Keep in mind that the business may have

sufficient funds to avoid having to borrow so

interest rates charged would have to be

highly competitive.

In the decline phase, businesses may

need to borrow but this could be so that

they can continue to pay operating

expenses caused by their reluctance to

cut costs or to pay dividends to

shareholders as the business’ current

cash flow is inadequate to do so.

In the decline phase, businesses may

need to borrow but this could be so that

they can continue to pay operating

expenses caused by their reluctance to

cut costs or to pay dividends to

shareholders as the business’ current

cash flow is inadequate to do so.

Banks lend to businesses in

this phase at their peril.

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