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The Key Questions

Five questions to answer about any business

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Five Questions flow

Start at value creation, then test capture, durability, operating scalability, and long-term defensibility.

Financial Statement Analysis

Read the three statements as one integrated system

Income Statement

Key questions

  • - Are gross margins stable or improving with scale?
  • - Is operating expense growth slower than revenue growth?
  • - How much of earnings quality comes from core operations?

Red flags

  • - Margin erosion despite revenue growth
  • - Large adjustments masking weak core profitability
  • - High dependence on one-time gains

Balance Sheet

Key questions

  • - Is working capital supporting growth or trapping cash?
  • - Is debt level appropriate for revenue predictability?
  • - How flexible is the capital structure under stress?

Red flags

  • - Rapid receivables buildup without matching cash
  • - Refinancing risk with narrow liquidity buffers
  • - Asset intensity rising without return improvement

Cash Flow

Key questions

  • - Does operating cash flow track operating earnings over time?
  • - Are growth investments translating into future cash generation?
  • - Is the business self-funding or externally dependent?

Red flags

  • - Persistent gap between earnings and operating cash flow
  • - Heavy financing dependence for routine operations
  • - Free cash flow deterioration without clear strategic payoff

Hover context

Focus on quality of earnings and whether profitability can persist through cycle changes.

Statement linkages

Net Income flows to Retained EarningsWorking Capital changes flow into Operating Cash FlowCapital Expenditures reduce Cash and create long-term assets

When Growth Kills

Diagnose when fast growth becomes a cash crisis

When Growth Kills

A profitable business can still fail by growing too fast. This happens when growth rate exceeds sustainable growth rate, cash-to-cash cycle is long, and the company cannot or will not access external capital.

The math

Required Working Capital = Incremental Revenue multiplied by Cash-to-Cash Days divided by 365

With a 90-day cash-to-cash cycle, each $1M of incremental revenue requires about $247K in additional working capital ($1,000,000 multiplied by 90 divided by 365).

  • - Slow growth to sustainable growth rate
  • - Raise debt and add interest burden
  • - Raise equity and dilute ownership
  • - Or run out of cash

Case example: 5.11 Tactical

  • - Sustainable growth rate was about 9 percent due to a 195-day inventory cycle.
  • - Attempting faster growth trapped cash in working capital.
  • - Value moved from $70M to $320M without equity value creation.
  • - Debt investment outperformed equity return.

Warning signs

  • - Earnings before interest, taxes, depreciation, and amortization is much higher than operating cash flow.
  • - Inventory days and accounts receivable days rise as revenue grows.
  • - Management repeatedly raises financing to fund operations instead of strategic investments.

Growth Kills cycle

Fast Growth
Working Capital Demand
Cash Shortfall
Need Financing
Crisis Risk

Six Integration Questions

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