Private companies performing well: is it time to embrace into a growth mindset?
Very few people question the important role that private companies play in contributing to the health and well-being of the nation. These businesses are responsible for more than 50% of GDP and 65% of new job creation so when they’re in good shape the nation is in good shape. The last 6 years have not been kind to small business but just maybe, things are getting better.
According to a report issued by Sageworks, year-on-year revenue growth has been compounded at 8.7% since 2011 and although the average gross profit margin has declined by 2.5 percentage points net profit has grown at a very impressive compound rate of 40% per year over the past three years. (Our own top 30% of clients in that same period have shown revenue growth of 60% and pre-tax profits growth of 225% - exceptional by any standards).
From the available information it’s obvious that this result has come from quite a significant increase in revenue accompanied by a much smaller increase on overheads, but as a % of revenue they have actually fallen. This probably indicates that inefficient businesses have been purged by the recession leaving market share at relatively low cost to the businesses that have been able to survive.
However, gross profit has grown at a slightly slower rate than revenue which is reflected by the reasonably significant drop in the GP%. That will arise for one or a combination of two reasons: average prices have fallen or cost of goods sold has risen. Management needs to keep a close eye on this because as the GP% falls the break-even level of revenue rises for any given level of overhead and the margin of safety shrinks and so business risk increases.
This is the sort of analysis and conversation that we have with our clients. We also tend to look at the number of transactions that are reflected in revenue because then you could make some judgments about the volume and pricing impacts on revenue.
Apart from being hugely concerned about the level of public debt the Sageworks report together with some other (often patchy) positive economic news that has been coming out in recent months gives us cause to be cautiously optimistic and maybe it’s time for business managers to be thinking about planning for continuing growth. After all, business cycles tend to look a bit like a wavy line. I believe it’s fair to say we’re not at the top of an economic cycle but whether we’re going into, at or coming out of the bottom of a cycle I’m not sure but my guess is we’re in that space so on the balance of probability, the future seems to look brighter than the past.