Any business worth doing is worth keeping it growing over the long term. How can we tell we are running a good busines? Financial Measures like Revenues, Costs, Profits, Cash-on-hand, tell us how our business is doing. Without such measures, we do not know. Such Measures, like profits, are purely indicators and is amoral. Making profits is the result of the delivery of a good value to customers. There is nothing bad or evil in making profit. It is what you do to make profits that decide whether it is good or evil.
Optimization of Resources - We must do
Without financial measures, we do not know how to optimize our usage of resources. Optimization of our God given talents and resources are thought in the parables of the Good Stewards (Mat 25:14-30, Luk_19:11-27). So, we must familiarize ourselves with all the measures.
Watch the Cash Flow besides the Profits & Loss
A company can make profits and yet still close down due to lack of cash. Profits is a computed and delayed measure. If the profit is realistically and accurately computed, it will result in increasing cash. If you have a large cash pool to start your business with, you can sustain a business without making profits for a number of years --- until you run out of cash or credit line.
So, we have a very basic principle, or saying, "Cash is King" or "He who has the cash has the say".
The key points in the business are:
- What is the Business Model ? How does the business make profits?
- What is the Profit&Loss Projection?
- What is the Cash-Flow ?
- What is the Balance Sheet?
- What is the Value of the Business?
1. The P&L statements tell us whether is business will make profit to survive. Key measures are Net Profit After Tax, Net Profit Margin %, Gross Margin%.
But it does not tell us how much resources, or capitals (cash, building, machineries, etc) are used in making the profits. So other measures are needed like:
2. Returns on Capital Employed (ROCE) , Economic Value Add (EVA) and EVA returns are measures for capital efficiency.
3. For listed company, the Market Value of the business and Shares Holders returns are important. A typical good measure used 3-5 year rolling Total Shareholder Return (TSR).
4. Since Cash is most important, cash flow measures are important too. Because profits are subjected to manipulations, financial analysts recommend the use of FCF Free Cash Flow. FCF = Net Operating Case - Capital Expenditure. It represents the cash that are in excess of the operation & capital needs of the company and can be freely used for dividends, shares buy back etc. Some others proposed used of structural free cash flow = Net income + depreciation + amortization +/- onetime items - capital expenditures.
Other Key Points
- Time have value. Watchout for the time value of money. A $1 now is of greater value than $1 at year end.
- Options have value. Keeping the decision options opened have value. If two plans give the same return, go for the one with greater options. A 3% interest rate for a 6-month and a 12-month fixed deposits are not equal in value.
Firstly, we realize that "Lay up treasures in heaven, not on earth Mt 6:20". Hence, the 1st portion of the profit is for the Lord. Secondly, profits is put back into the business as longer term investment for the future profits. Lastly, take it out and distribute to the owners (shares-holders) as returns for their investment.