E-M8 Entrepreneurial Management for Eternal Mission

UNDERSTSTAND MONEY

Money and Finance are the controls that separate the organizations that will go on from the ones that fail. People affect change. They use tools and processes to do so. The change happens in the markets. But the measure of it all is money. Lack of money, is the only thing that will shut down any organization, since money is needed to run all other aspects of the company.  

Money is all around us and yet, it is one of the least understood objects in our life. Money is – cash, which is typically the money on the bank account of the firm; petty cash[1]; and securities[2], such as CDs[3], money market[4] accounts and bonds[5]. 

Money is used to measure and reward performance. It is used to store wealth and to produce wealth. Money is a symbol of trust. The value of money changes with time and space.

To understand money we must learn its language – language of Finance. Language of Finance has many words to describe some of the key concepts; so, rather then clutter the guide, a number of footnotes for key terms has been included. Financial disciplines exist to help plan, manage and report an organization’s ability to sustain itself and generate money. The management, investors and the government care a great deal about the company’s financial performance.

 

THREE VIEWS OF MONEY

There are three very different disciplines that look at money. The apparent similarities are misleading, since beyond the general format of the key statements and some shared terminology, these disciplines are a world apart. Each discipline has a different audience in mind. Finance focuses on investors and bankers. Tax accounting is primarily for the purpose of paying taxes and reporting the performance to the government. Managerial accounting exists to give the management the necessary information to make good business decisions. A clear understanding of the differences between these disciplines, their vocabularies and their goals is a necessary first step to understanding money.  

Tax or traditional accounting focuses on reporting what already happened. There are strict government guidelines since the government is the final customer. Value is based on historic purchase price and accuracy is based on precision. In the USA and many English speaking countries an accrual[6] accounting method and double entry bookkeeping[7] are followed. Depreciation[8] and amortization[9], burden[10] allocation and many other approximations are utilized. The goal of tax accounting is to record the information in compliance with government standard while minimizing the tax burden.

Managerial or cost accounting is focused on providing the information necessary for good managerial decision making. Historic[11] costs are only relevant to the degree that they approximate the present. The information accuracy is measured by timeliness and usefulness in the decision making. The goals are usually to generate a profit[12], protect cash flow[13] and reduce costs[14]. This is often done by managing direct[15] and indirect[16], variable[17], incremental[18] and fixed[19] costs; covering the overhead[20]; generating quick payback[21] and increasing the capacity[22] utilization.

Finance focuses on presenting the information to the investors[23], creditors[24], such as banks, and owners. The focus is on the future and the cash flows. The real market valuation of assets is paramount. Pro forma[25] financial statements are the tool of financial accounting. Business and market flexibility, resiliency and awareness are the measures of accuracy. A number of ratios[26] are used to allow for quick comparative analysis of multiple investments. 

 

Financial Statements

 

All the financial and accounting disciplines use the same basic format to look at numbers. These key documents are Balance Sheet, Income Statement and Statement of Cash Flows. 

Balance Sheet, which is an organization’s Statement of Net Worth, lists possessions (assets) and than balances them out with debts (liabilities) and the equity of the owners.

Income Statement, which is a lot like a personal budget, lists revenues[27], such as sales or rent; expenses (costs); and the profit or loss, which is the difference being. Income Statement serves as a bridge to get from one balance sheet to the next. This is why most ratios will link those two documents.

Finally, the statement of Cash Flows makes the adjustments necessary to move us between the accrual system and cash system of accounting. It is a lot like reconciling a checkbook to determine how much money is really available.

PROFITS VS CASHFLOWS

No matter how profitable the company and how much others owe the firm, if there is no money in the bank a firm will default on the payments and may even be forced in to bankruptcy. There is a need to always have enough cash to cover the upcoming bills.

It is the cash generating ability rather than ability to generate a profit that is crucial to success. Profit is an accounting value, which is determined based on historic information, and is primarily used to figure out the taxes. While profit may turn in to cash eventually, it is only relevant to the degree to which it will help us generate cash in the future. Cash, on the other hand, is a business asset that we can easily trade for other business assets, or to cover business costs, or to give back to the investors.

An organization has to have an ability to generate cash. A business that consistently generates cash has the opportunity to exercise greater control over the future. A business that uses legitimate means to generate cash is a business that adds more value than it consumes. So, those involved with this business will prosper.

MONEY AND INFLATION

One reason we focus on cash, is that the value of money is dynamic. Money is much more valuable when you need it, than when you do not. Value of money varies within different parts of the same city and much more so, globally.

Value of money changes with time. In other words, a dollar today is worth more than a dollar tomorrow. The process of change of value of money is called inflation and is a direct result of human greed. Since we want more money that is precisely what we get. But since the overall value has not increased, the value of money has to thus proportionally decrease. So our society continues in the dance of the illusion, where we make more money than value, but rather than focus on creating more value, we focus on making even more money.

Interestingly enough a little bit of inflation actually stimulates the economy, since it does not allow any capital to sit still and forces everyone to put it to work or suffer from the dissipation.

Which is why as a business, we cannot keep too much cash on hand, either. Cash sitting idly does not produce more cash. In the short term, investing cash in the money markets may be an option, but in the long run, cash should either be invested in something more productive or returned to the investors.

Time-value[28] of money is largely established through the investment activity that is required to offset the inflation. The concept of time-value of money is closely tied with the concept of inflation.

MONEY IS A SYMBOL OF TRUST

Time value of money brings us to the next concept. Money is very closely linked with trust. Money is a medium of exchange between individuals. So is trust. The only thing that makes money worth anything is our trust in its value.

If you did not trust the individuals, businesses or the government to honor the dollar, what would a dollar be worth? Not much, certainly less then the cost to print it. In fact, most of the money in US is not even printed; it is but a digit in a computer record somewhere. In the lending industry the maxim applies even more – you get the rate based on the level of trust. If you have the record of paying your bills, the banks trust you. They will think of you as a lesser risk.

To illustrate this point, consider two extremes: someone you trust completely, and someone you do not trust at all.  Someone you trust completely can ask you to borrow anything and get it for free. Someone you do not trust at all will not get anything no matter how much they are willing to pay.    

But if money is indeed trust, why does the Bible say that “The love of money is root of all kinds of evil?” What is so wrong about seeking trust? Trust is not evil. But when people seek to honor each other, there is no more room for God. In dishonoring the poor we dishonor their Maker. That is why time after time the scriptures encourage us to give to those in need based on our trust in God rather than people. It is the love of the apparent trust and honor given by the people above the love of God that is a root of all kinds of evil.

Money exists for the sole purpose of facilitating transactions. So, by reducing transactional costs, we can increase the benefit derived by both sides of the trade and thus generate wealth.

There is a level of trust built in to society. We trust most people to obey laws most of the time. We trust people to act in their self interest. We trust that their behavior today is going to be similar to one yesterday. All of this trust is based on our practical experience of what to expect. We also trust to have certain types of experiences with people in certain professions. We are surprised if our expectations are exceeded or not met. But to create extraordinary wealth, we must create an environment of extraordinary trust. Building extraordinary trust takes extraordinary behavior and circumstances, which we aim to facilitate by working through this guide.  Learning the financial tools and controls allows us to put procedures in place that make it safer to create trust.

MONEY IS A MEASURE AND A REWARD

 A key measure of our success in business is ability to create money and trust. Trust is essential for effective Management. It significantly reduces costs and initial outlays for Manpower and Means of Production. Trust allows for streamlined Method of Operations, with no double checks, second guessing the decisions and minimum of overhead. Trust drives our ability to capture new Markets and defines what level of prices we will be able to charge. It enables us to use Money to make optimal decisions; helps us mitigate our risks and allows for our Mission to be accomplished.

Can a company, whose customers trust it, fail? Absolutely! That happens often enough. Employees, banks and vendors are just some of the other stakeholders whose lack of trust is enough to shut the company down. Similarly, if the market trusts a company to create value and the company fails to do so, the erosion of trust can be almost instantaneous.

Money is a powerful metric that allows us to measure every other aspect of our organization. Financial ratios allow us to measure and reward the high achievers. Like any measure or a symbol, monetary measurements can be manipulated, but unlike the measurements that rely on non-monetary metrics, there are well established systems of checks and balances that can be put in place to avert such manipulation or make it obvious as it happens.

It is the commonality of the dollars and cents as a unit of measurement for various aspects of business that unleashes the power to compare, contrast and focus on the areas of greatest potential improvement while not neglecting the rest of the organization.

Summary

An organization that produces money has no problems attracting managers, employees, vendors and investors. It can pursue its goals, while being socially responsible. It can invest in the future, rather than borrow from it.

Money is a measure of value that a business is adding and the means necessary to engage in the activities. Money is a medium of exchange. It is a symbol of status and trust. Money is not the end goal for the organizations, but it is the end goal for the investors. Moreover, money is necessary to get to the end goal.

 

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[1]Petty Cash is the cash stored at the business location for small purchases

[2] Securities are documents that represent an interest in something, typically they represent a debt or ownership stake in other businesses or government

[3]CD or Certificate of Deposit use to be a popular way to earn a little bit of interest on a short term investment with the bank, with the advent of high interest money market accounts CDs have less usefulness

[4]Money Market accounts are like a fancy version of a savings account in that they can generate higher interest than either money in a savings or checking accounts, but usually as a price there are some restrictions on how easily and frequently money can be removed from.

[5] Bond is a debt of a large organization that can be bought or sold on the open market, the quality of the underlying business will determine the quality of the bond, and thus the discount or a premium that the market is willing to pay for it.

[6] Accrual accounting method records costs in the time period when the related benefit was derived, as opposed to cash accounting which records costs as they are spent.

[7] Double entry bookkeeping system follows a strict rule that any entry has to have a counterpart to balance out the value of the possessions, debt obligations and equity in the business.

[8] In order to accommodate the accrual accounting, rather than record the cost of purchasing land and equipment ride away, this cost is distributed over a predetermined number of years based on formulas and rules that are defined by the government. Depreciation is important, since it impacts the time when we get the tax credit for the money that we spent.

[9] Amortization is exactly like depreciation in concept, except it applies to the value of consulting services and intangible assets (known as goodwill), that we may buy in a given time period, but have many years to enjoy their benefit.

[10] Burden allocation is a way to spread (allocate) the costs that cannot be traced to a particular product that we produce. Burden is commonly allocated against labor hours, labor costs, machine hours, or material costs. Allocation can act as a tax, by increasing the recorded cost of the actual product. As such, burden rates, can often suggest misleading actions and should be used with care for managerial accounting.

[11] Historic or book costs are based on purchase prices of the components and adjustments made based on depreciation, amortization, burden allocation, etc. As such they do not represent the actual market values and while required for accounting are often misleading for managerial and finance purposes.

[12] Profit is sometimes referred to as income, gain, or return. Profit needs to be maximized for the investors, minimized for tax purposes and be realistic for managers. The opposite of profit is loss.

[13] Cash flow is the change in amount of cash that is happening in the business. It is often a more meaningful number then profit, since one of key purposes of a business is to generate cash.  Cash is the only necessity to staying in business and any activity that generates cash without depleting cash generating ability is an activity that is adding value to the business.

[14] Costs, also known as expenses are means by which money leaves the company. Managing costs is an essential ongoing responsibility of the workforce.

[15] Direct cost is a cost that can be attributed to production of the individual part. Typical direct costs are materials, contracted services and direct labor (provided that if this part is not produced, this cost would not occur or be applied to a different part).

[16] Indirect cost is any cost that cannot be traced to the individual part produced. Typical indirect costs are costs of building and machinery, support and management costs, etc. 

[17] Variable costs change in proportion to the production level. An example is a contractor who only gets paid if there was complete.

[18] Incremental costs change with production levels, but in chunks or increments. An example of this would be a temporary employee who is only working when there is work, but has to be hired in daily increments.

[19] Fixed costs do not change with production levels. An example is a key full-time employee who gets paid no matter what the workload.

[20] All of the indirect costs together are called overhead.

[21] Payback is the period of time it takes for an investment to pay for itself.

[22] Capacity is the ability to produce without substantially changing incremental and fixed costs. Utilizing all available capacity if used to satisfy the market, rather then build up inventory, is considered to be the most efficient place to operate.

[23] Investors have an ownership stake in a business, though are typically not involved in running it.

[24] Creditors are people or organizations to whom we owe money. Creditors can have their credits secured by our property (usually by use of a lien). All other creditors are considered unsecured.

[25] Pro forma financial statements are a projection of what we would like them to look like in the future.

[26] Ratio is a number that is a result of taking one number in relationship to another.

[27] Revenue (sometimes referred to as gross revenue or gross income) is a source of money coming in to the business.

[28] Time value of money is the interest rate that one is willing to pay to get future money today.