How can a successfully growing firm fall into a growth trap? How can a successfully growing firm fall into a growth tra

Question

What will be an ideal response?

Answer 1

Successful growth seldom happens on its own; it occurs only when a number of factors are carefully considered and well managed. When a business experiences rapid growth in sales volume, its income statements will generally reflect growing profits. However, rapid growth in sales and profits may be hazardous to the company's cash flows. A growth trap can occur because growth tends to demand additional cash faster than it can be generated in the form of increased profits. Inventory, for example, must be expanded as sales volume increases. Additional dollars must be spent on merchandise or raw materials to accommodate the higher level of sales. Similarly, accounts receivable must be expanded proportionately to meet the increased sales volume. A profitable business can quickly find itself in a financial bind, growing while its bank accounts dwindle. The growth problem is particularly acute for small companies. Increasing sales by 100 percent is easier for a small venture than for a Fortune 500 firm, but doubling sales volume makes an enterprise a much different business. Combined with difficulty in obtaining external funding, this may have unfavorable effects if cash is not managed carefully. In short, a high-growth firm's need for additional financing may exceed its available resources, even though the venture is profitable. Without additional resources, the company's cash balances may decline sharply, leaving it in an uncertain financial position.