A start-up business will usually go through a number of identifiable stages during its lifetime. The four main stages are the start-up stage, growth stage, maturity stage, and the decline stage collectively known as the business life cycle stages.
It is important to understand that the length of the business life cycle and of each individual stage will depend on the particular business under consideration and can range from months to years.
Sales and the Business Life Cycle Stages
The particular stage a business is currently operating in is determined by its level of sales revenue relative to previous periods; this is demonstrated in the business life cycle stages graph below.
Each of the four business life cycle stages has its own characteristics and problems and determines among other things the particular funding and working capital requirements of the business at that point in time.
The fours stages are discussed in turn below.
The start-up stage is the first of the business life cycle stages and takes the business from its initial idea through to launch and first sales.
During the start-up stage sales are minimal and grow slowly and erratically. The business incurs trading losses due to the high level of operating expenses which in turn erodes its equity base. In addition, to launch the operation the business needs to invest heavily in long term assets such as property, plant, and equipment, and current assets and working capital such as inventory.
While the business needs substantial funding, its cash position is weak and unfortunately the reduced equity base together with an inexperienced management team, lack of collateral, and lack of ability to make repayments, make it difficult for a business to obtain debt finance. As a result during this stage of its business life cycle the business is likely to have to rely on alternative funding sources such as, for example, bootstrapping, personal funds, loans from friends and family, and grants to fund its operations.
The growth stage is the stage during which the business starts to establish itself in the market place and gains customers.
During the growth stage sales are substantial and growing rapidly. The business starts to generate trading profits for the first time as the sales now exceed operating expenses.
Unfortunately sales growth leads to a substantial increase in the working capital requirement as the business starts to increase its inventory levels to satisfy customer demand and to offer credit terms to customers, increasing accounts receivable.
While the business still needs substantial amounts of cash to fund growth, its profits are starting to increase the equity base, the management team are more experienced, and collateral and ability to repay have improved. The business is therefore able to seek out debt finance in addition to equity finance to fund its operations.
The maturity stage is the third of the business life cycle stages during which the business is truly established in its industry with a proven business model.
During the maturity stage the sales growth rate has slowed and sales and profits have stabilized. The business no longer needs to invest so heavily in additional sums for property, plant, equipment and inventory.
The profits have improved the equity base of the business which now has an experienced management team and sufficient collateral to raise substantial amounts of debt and equity finance if required. The business may even have surplus cash and uses this to pay dividends to equity shareholders.
The decline stage is the final stage of the business life cycle model where the business starts to lose market share and sales start to decline.
Ideally the business will recognize the start of the decline stage and take action such as investing in its current market place to maintain the business in a steady state in its maturity stage, or investing in new opportunities to move the business into a further growth and expansion stage, or exiting the business in a controlled manner.
If no action is taken the business will continue into the decline stage, sales will fall and unless operating expenses are reduced, eventually losses will be made.
The declining sales figures reduce the amount of cash available. Unfortunately businesses in this stage often try to maintain dividends which, together with the trading losses, weaken the equity base and the ability of the business to borrow additional funds. In addition the banks will often recognize that the business is in its decline stage and be reluctant to lend additional debt finance.
Each of the four business life cycle stages has its own characteristics, problems and goals. The start-up stage is about survival and building a foundation for the future, the growth stage is all about increasing sales and in particular accelerating the sales growth rate, the maturity stage is concerned with maintaining stable profit levels, and finally the decline stage is about trying to reverse the decline by exploiting current and new markets.
By adjusting the assumptions used to reflect the current goals the financial projections template can be used at any stage in the lifetime of the business; however, in order to be able to plan effectively a business needs to understand which of the four business life cycle stages it is currently in.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University.