Financial Tips for Beginners

Financial Tips for Beginners: What are some of the key insights from the field of finance for business owners, managers and investors?

Let me walk you through four big ideas that can help you improve your business and build a better understanding of decision making and financial reporting.

 Finance Idea No. 1 

Profit is not necessarily the same as cash flow. Let's say you are full of ideas. You like to invent stuff. You have come up with a breakthrough product and got a prototype working.

 However, your personal strength is really in inventing, not in manufacturing nor in selling. So you get somebody else to do the manufacturing of your product for you.

 They produce the goods according to your specifications, ship them to you, and you pay cash on delivery. 

You also get somebody else for the selling of the product to consumers. You ship the goods to a retailer, but instead of the retailer paying you immediately, you will receive payment after 30 days. 

This month, you buy 100 units at $80 each and sell 50 units at $100 each. The other 50 units stay in inventory. 

How much profit do you make? You deliver and sell 50 units at dollar 100 each, so your revenue is $5,000. The cost to you of sourcing those 50 units that you have now sold is 50 units at $80 each. 

So your cost of goods sold is $4,000. In short, you sell 50 units at $20 margin per unit, so generate a profit of $1,000. How much cash flow do you generate? Well, you don't get paid by the retailer until one month from now, so cash in is zero. 

You paid your supplier on delivery, so cash out is $8,000. Total cash flow is negative $8,000. Profit on your shipment is recognized when you deliver the goods to your customer, the retailer. 

Cash flow is recognized when cash comes in or cash flows out. You could be profitable yet go bankrupt. 

Finance Idea No. 2

Each financial statement tells a story. The balance sheet gives you an overview of assets, liabilities, and equity. It shows what we own on the left and what we owe on the right. The income statement shows you how revenue minus expenses equals profit or loss, or in other words, how sales minus costs equals income or loss. 

The cash flow statement shows you how you got from the cash balance at the start of the year through cash inflows and cash outflows during the year to the cash balance at the end of the year. 

A balance sheet is a picture at a point in time, usually the end of the month, end of the quarter, or end of the year. An income statement is a movie of profitability during a month, quarter, or year. A cash flow statement is a documentary movie about movements in the most fascinating account on the balance cash.

Finance Idea No. 3

What a company is worth on paper based on the balance sheet is not necessarily the same as market value, what someone is willing to pay for it. 

Let's look at Apple Inc. The book value of its equity on the balance sheet of March 30, 2019 is around $106 billion, the number of outstanding 4.7 billion units. So the book value per share is around $22.55. If you look at the market value of the share price in early May 2019, you see the share price around $200. Book value or accounting value is based on the company's historical financial results. 

Looking back, market value or economic value depends on the expectations of investors for the future of the company. 

Finance Idea No. 4 

There are many ways to drive operating income. If you listen to CEO's and CFO's, it sometimes seems that the only thing they can think of is cost cutting, cost cutting and more cost cutting. 

While that could certainly be an appropriate way forward, there are more options to choose from. 

Price are you charging a price to your customers for your goods and services that accurately reflects the value you are creating for them? What opportunities do you have to sell more units? Can you focus more resources on selling the higher margin products and services in your portfolio versus the lower margin ones? 

Productivity can you generate the same amount of output with fewer resources or more output with the same amount of resources? Sourcing? Can you renegotiate your contract with your existing suppliers to get lower price or more value? Or can you find alternative suppliers that give you a better deal? Spending more can you spend more on research and development to develop your product or service faster and better and generate more revenue and margin? Can you spend more on marketing to establish your brand? Can you spend more on learning.