Slater and Gordon and the cost of growth: Lessons from the big end of town

“Revenue is vanity,
Profit is sanity
Cash is reality”
Slater and Gordon is a large legal firm, listed on the Australian Stock Exchange. It had been growing by acquisition since the 2010 financial year (FY10), but this came to an abrupt halt about 18 months ago. I thought it would be interesting to see if the company’s story has some lessons that might help owners of growing small and medium size businesses do it better.
If you haven’t been following the story of Stater and Gordon you can read this comprehensive summary. As things stand, its position is precarious but it is likely to survive, although only by wiping out their current shareholders and debt providers.
The Slater and Gordon story can be divided into two parts: the growth phase up to the end of the 2015 financial year (FY15) and its denouement in the 2016 financial year (FY16). This case study focuses on the first part of the story.
Over a six-year period, from FY10 to FY15, Slater and Gordon increased revenue by more than 300%, from $125 million in FY10 to $525 million in FY15; staff numbers by more than 400%, from around 1,000 to 5,350; and offices from 50 to 95.
The graphs below show the major trends arising from this growth.
The first graph shows how tricky it can be to manage growth. Slater and Gordon’s revenue trended up but its net profit was more variable (from $29 million in FY10, to $96 million in FY14, and $85 million in FY15) and its net margin (net profit/revenue) never exceeded the 23.1% made in FY10.
Growth is also expensive. The other three charts show that Slater and Gordon’s growth required an increase to the amount of money tied up in working capital of $270 million; acquisitions of $1.6 billion; and an increase in the amount of debt by $676 million, and equity by $1.2 billion.
So, if you’re an SME owner with plans to grow your business, how do you keep on top of how much cash is being chewed up, and where it is going?
One answer is to use a funds flow statement, which is constructed by comparing the balance sheet from one period against the balance sheet of a later period. It’s a great tool that helps business owners immediately grasp the drivers of the change in their cash position.
When comparing balance sheets of different periods there are some rules you need to know. They are:
Next, you need to split the balance sheet accounts into four main categories: working capital, investment, funding and earnings. A further division of the funding category, into funding by debt, equity and other sources, will help a more informed understanding of the messages from the funds flow statement.
The table below sets out Slater and Gordon’s balance sheet for each financial year from 2010 to 2015. You will note I’ve set out the categories of working capital, investment, funding and earnings.
Immediately below is the funds flow statement, which has been derived by reclassifying and organising the balance sheet information using the rules outlined above.
Okay, if you were the owner of this business you can now see for each period:
The waterfall graph below aggregates the information from the funds flow statement to show how the movement in cash over that period is derived:
You can see:
Slater and Gordon’s earnings contributed $201 million to the overall cashflow of the business.
But, the change in working capital used $266 million of cash.
This means the operating cashflow of the business was negative, to the tune of $65 million.
The business spent $1.58 billion dollars on acquisitions.
It had a total funding need of $1.645 billion dollars, which it met by raising additional equity of just over $1 billion, additional debt of $675 million and other funding of $18 million.
The conclusion from this analysis is that the surplus of funding raised over the funding need has driven the $67 million increase in cash and cash equivalents.
What then are the lessons for owners of growing small and medium size businesses from the Slater and Gordon story?
One final lesson — make sure your accounts are up to date and properly recorded. Review them regularly — every month at a minimum. They are a source of valuable information that will help you make good decisions.
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