“Have you ever heard of a term called MIFROG? If so, can you explain what it means and how I should use it in my business plans?”
MIFROG stands for Maximum Internally Financed Rate of Growth. In today’s economy most small businesses are self funding their growth. That means there are limits to how fast a company can grow and be safe.
Just about every business owner has faced the challenge of having cash flow dry up just as sales take off. Especially after a down market, who wouldn’t want a lot of new business. However, new orders are a double-edged sword.
Previous months of down sales mean limited funds are available to put toward growth and cash on hand. Fueling marketing and sales, drains reserves. As volume expands you lay out more money to produce and deliver what’s been sold. Usually customers pay after delivery, long after the company has paid for rent, materials, salaries and benefits, etc. It’s the gap between fueling up, producing, delivery and collecting that can be deadly for small-business owners.
Growth can come too fast. Think of it as binge growth. The business takes on too much, or overspends to achieve growth, then falls back as problems arise and cash flow dries up. Profits dwindle and the business ends up behind the proverbial eight ball.
Margins can drop just as the company gets a major boost in sales. Costs jump up due to inflation. Or problems and extra costs crop up due to expanded production. Sales increases don’t keep up with costs, as price-conscious customers resist higher fees.
Margins can also fall short when the company cuts prices in order to move goods or services, without negotiating lower material and payroll costs. The company makes less on each product or service delivered. Shortfall accelerates as sales take off.
That’s where MIFROG comes in. Published by Neil Churchill, professor of entrepreneurship at INSEAD, and John Mullins, professor at the University of Denver and London School of Economics, MIFROG helps to predict how much growth is going to be too much. My thanks go out to one of our clients who introduced me to this nifty tool.
Here’s how MIFROG works. It takes into account two major categories that are affected by growth: cash flow and profitability. The higher the gross profit percent and net profit percent, the bigger the sustainable growth rate. Same is true for cash flow. Turning over inventory rapidly, negotiating longer bill payment terms and getting clients to pay quickly will loosen up cash to support growth.
To calculate MIFROG, you’re going to need to pull together a few numbers:
- average days of inventory;
- average days of accounts receivable (a/r) outstanding (average length of time it takes customers to pay you);
- average days of accounts payable (a/p) outstanding (average number of days you can count of vendors to float your bills);
- cost of goods sold (COGS) percent;
- gross profit margin percent;
- net profit margin percent (EBITDA).
Now it’s time for some calculations:
- Average days in inventory + average a/r days = number of trade cycle days;
- Use amount derived from No. 1 – (minus) average a/p days = days of investment in working capital;
- Use the amount derived from No. 2 / No. 1 = investment in working capital / trade cycle;
- COGS percent x (times) the amount derived from No. 3 = amount of COGS to produce $1 in the trade cycle;
- Gross margin percent – (minus) net margin percent = overhead cash to produce $1 of sales;
- Use the amount derived from No. 5 x 50 percent = overhead per $1 of sales as part of trade cycle;
- Use the amount derived from No. 4 + (plus) the amount derived from No. 6 = cash needed to generate $1 in sales ;
- Net margin percent / the amount derived from No. 7 cash needed to generate $1 of sales = maximum growth rate per trade cycle based on cash generated / cash needed;
- Use the amount derived from No. 8 / the amount derived from No. 1 = maximum growth in 1 day;
- Use No. 9 x 365 days = maximum growth rate / year.
Finding the calculation a bit challenging? Give us a call. We can run your numbers through a model in a snap.
