How fast can a business grow using only the cash flow it generates itself? MIFROG is the "maximum internally financiable rate of growth". Calculating it is an interesting academic exercise, but more useful is understanding how the result can be driven higher.
MIFROG is essentially determined by two sets of factors. The first is the length of the "Operating Cash Cycle". The second is profitability - including both gross and net margin.
The "Operating Cash Cycle" measures the length of time cash is locked up in a business, and is calculated by adding the number of average days stock and the number of average days debtors (the Trade Cycle), and deducting the average days payables.
At this point, let me say that if numbers frighten you, you should skip the next three paragraphs and start again at the paragraph starting with the words "Welcome back...".
A business holding stock for an average of 60 days and collecting its debtors on an average of 45 days has a trade cycle of 105 days. If it is paying its suppliers on an average of 30 days, it has an OCC of 75 days (105 less 30).
Lets assume it has a gross margin of 40%, overheads of 35% and a net margin before depreciation and tax of 5%. For every dollar in revenue it earns, it generates 5 cents in cash. How much cash does it need to make that dollar? Cost of sales is 60 cents, but only 75/105ths of this is required every trade cycle - in our example, 43 cents. Overheads are 35 cents, but assuming these are incurred evenly throughout the period, only 50% of this is required in cash - 17.5 cents.
So, using our example, to generate $1 in sales, we require 60.5 cents. Given we only generate 5 cents per cycle, the most we can grow per cycle is 8.26% - 5/60.5. To convert this to an annual growth rate, we multiply by 365 and divide by the length of the Trade Cycle - in this case 8.26/105 x 365 = 28.7%.
Welcome back numero-phobes! The main points are that there are two key drivers of limits to self funded growth. The quicker the business turns over stock and debtors, the higher the MIFROG. And the higher the margins - Gross and Net, again, the higher the MIFROG.
Is the number for MIFROG itself useful? If your client is telling you he/ she plans to say, double revenues over the next 12 months, have a look at the key numbers discussed above. In our example (not uncommon), the limits to self funded growth (or MIFROG) is 28.7% P.A. 100% is not achievable without serious work on the key MIFROG drivers - or without access to external funding.
So, a useful number to know, and a good exercise to go through to look at what trade-offs might be required in order to drive MIFROG closer to planned growth.
The Cash Flow Ninjas
