Now that the recession in the United States is technically over, are our companies poised for growth? How fast can we grow our businesses? After months of downsizing and belt-tightening, do we still remember what to do?

Maybe we should ask a better question: How fast should we grow our companies so that we really achieve our goals and create sustainable businesses? We've seen in the end of the last century and the beginning of this one that it's possible to grow at astounding rates, but it's hard—very hard—to sustain those rates.

Often, we become used to dealing with one set of problems (slowdowns, layoffs) and forget that relief from those problems (economic growth) has its own set of challenges. While it will certainly be refreshing to have to deal with increasing revenues, profits, and staffing, it may be helpful to look realistically at what we'll face in the next part of the economic cycle.

To those of us still suffering from the pain of too little business, thinking about dealing with growth may seem like fantasizing about winning the lottery—amusing, but of little practical use. Yet I suggest that now is precisely the time to consider more carefully how fast we want to grow; once growth strikes, we won't have that luxury. Let's think about this future by considering the past.

In 1957, David Packard, cofounder of Hewlett-Packard Company, told attendees at the Seventh Region IRE Conference how Hewlett-Packard was managing their rapid growth. He laid great importance on the company's objectives: focusing on a specific field, putting efforts into making a true contribution, providing security and opportunity for employees, and fulfilling its responsibility to the communities in which it existed.

Crucial to achieving these objectives, he said, were two more key goals: growing as rapidly as they could on a pay-as-you-go basis and earning at least a 10-percent profit each month. Profit is key to managing growth, because it not only enables you to provide security and opportunity, but it allows you to remain independent—you can fund growth without seeking outside capital. Because many small companies need such an infusion of outside capital to sustain their desired growth, they end up being purchased.

In this talk, Packard focused on managing growth successfully. He gave a rule of thumb for the maximum rate a company could grow and still live within its means (which, for him, meant self-funding: growth based on profits, not external investments or loans).

What was his magic formula for growing without losing financial control? "The percentage increase in sales which you can finance each year is equal to your percentage of profit after taxes times your capital turnover. Capital turnover is defined as the number of dollars in sales you can produce per year for each dollar of capital you have invested in your business."

By this rule, if you want to grow quickly through self-funding, you need to be sufficiently profitable, you need sufficient capital turnover (productivity), and you need to reinvest your profit into your company.

Let's consider the two factors, profit and capital turnover, separately. Most of us understand profit percentages: It's simply the money left over at the end of the year after paying all the bills (including taxes), divided by the company's total revenue. Packard's rule of thumb says that the rate at which you can grow is directly proportional to your profit percentage: If you increase your profit percentage by 25 percent, you can grow 25 percent faster. Conversely, if your profits decline by 25 percent, you should lower your company's growth rate by that same 25 percent.

Capital turnover may be less familiar. A company's capital (or capital assets) consists of the money, equipment, buildings, and land that it owns to produce goods and services. In other words, "You need money to make money." Without money to pay for raw materials or the equipment to assemble products, you won't be able to build products to sell to customers. Without sales, you have no revenue (the money you receive for products and services sold). Capital turnover describes roughly how many dollars in revenue you can generate for each dollar invested in the company's capital assets.

To figure out your capital turnover, divide your annual revenue by the total value of your capital assets. To illustrate how to manage growth using profit and capital turnover, let's say your company has $2 million in revenue, $500,000 in capital assets, and earns 10-percent profit after taxes this year. By Packard's formula, your capital turnover is 4.0 (2,000,000 divided by 500,000). Your profit in dollars is 10 percent of $2 million, or $200,000. At the end of the year, you invest that $200,000 in the company, raising its capital assets from $500,000 to $700,000. If your capital turnover remains at 4.0, then you can generate $2.8 million in revenue next year. That's 40 percent more revenue than this year, the same result that you get from using Packard's formula: 4.0 times 10 percent. If you try to grow faster than that, you'll likely find you need external sources of funds to increase your capital.

Packard devised this rule of thumb to bound Hewlett-Packard's growth so the company wouldn't be subject to acquisition and dilution of the principles he held dear. It should serve as a useful financial planning tool for others with a similar goal of sustainable growth.

Of course, this model only scratches the surface on the limits to growth of an organization. For a company to grow, there has to be sufficient demand for the products or services offered. The company must have the organizational capacity to grow at the desired rate, including the ability to hire and train employees and scalable processes to manage higher volumes. There must be sufficient resources to build the products. There may be governmentally imposed limits to your growth because of pollution or traffic concerns. Finally, you may want to consider whether your product is needed and how it will help the world and your shareholders. The financial constraints we've discussed, as important as they are, are only one of a number of possible constraints.

How will you decide how fast you want your company to grow? Consider first how your long-term goals are affected (and how they affect) key systems: financial, organizational, ecological, or whatever makes sense for you. Then create a rule of thumb that you can use to guide your decisions. You can explore Packard's ideas more fully by downloading the model and trying it out. Once you've experienced the model, share your thoughts in the Pegasus Forum.

"Growth from Performance," a speech by David Packard, was presented at the Seventh Region IRE Conference on April 24, 1957. It is quoted here courtesy and by permission of the Agilent Technologies Archives and Karen Lewis, Archivist. Revenue and profit results from 1950 through 1957 are courtesy of Patricia Parsons at the Agilent Technologies Archives.

Using the Model
To use the model, you'll need to download two files—the "current model" and the "isee Player" (the ithink® Runtime for the At Any Rate model series) that runs the model. Both are located in the "Get" section toward the top of the right-hand column. You'll then need to install the isee Player on your computer. (Once you have installed the isee Player on your computer, you no longer have to go through this process unless the reader is updated.)

1) Download the "Current Model"
• Click "Current Model."
• Choose "Save this file to a disk" and click "okay."
• In "Save As," save the ITR file to your desktop (or to a folder of your choosing).

2) Download and install the "isee Player"
• Follow the instructions on the isee Systems site.
After you install the isee Player, to run the model, you can go to your desktop and double-click on "model1.itr" or start the ithink® program and use the "file open" command to locate and open the model1.itr file.

You are ready to begin. Feel free to play with the model. We've put more content in it than we've described in this column. Try different things. If you've got an interesting idea, a question, or a comment, go to our Pegasus Forum. We'd enjoy hearing from you. 

This learning lab was developed using the ithink® software, a computer simulation modeling package developed and distributed by isee Systems.