Many successful entrepreneurs have created their company thanks to their capacity for innovation, entrepreneurship, and commercial energy. These qualities are necessary to create and grow a business. But at some point in the life cycle of the company, the financial dimension comes into play and not all entrepreneurs are clear about the strategic role of finance in business.
The financial vision of a business is made up of three elements: cash, risk and value.
It doesn’t seem too difficult. If we want to manage the company with a financial vision, we must think in terms of cash, risk and value.
The cash is the main component of “financial reasoning”. the directors generally, they are most concerned about sales. And it’s okay, it’s the first thing they should be concerned. But sales are only the beginning. Sales are followed by margins, that they must be positive and to these the collections, so that these margins become cash.
The cash is what is available to acquire more resources and continue growing;
Therefore, we have a very interesting first relationship that we show below:
Sales ==> Margins ==> Cash (net result + amortizations)
According to accounting techniques, the cash generated by a company is equivalent to the profits in the income statement plus the amortizations. But this definition is too theoretical since this “accounting” cash can be “retained” in accounts receivable, inventories or payments on previously contracted debts and not be available for new investments. Therefore, the concept of cash available is the one shown in the attached table:
Cash – financial need for working capital – investments in equipment necessary for the operation of the business – payments of financial debt = cash flow available.
The second component of managing corporate finance is the risk. We can define risk as “the uncertainty that the expected result will occur.” Therefore, if we apply this concept to that of cash generation, considering that cash is the end result of all the operations carried out, we can conclude that the company’s risk is related to the greater or lesser uncertainty that the cash is generated. planned. For a company consolidated in a stable market, the probability that the expected cash will not be generated is lower than , for example, for a technology-based start-up that is developing a new product and does not yet have only clients. Therefore, the second company has a higher risk than the first.
It is important to introduce here an action that is fundamental in the world of finance and that is the return-risk binomial: the higher the business risk, the more return investors will demand. Therefore, both to attract new capital to the contracting of loans and credits , the risk perceived by the market in relation to the company determine whether or not there is a possibility of capturing the resources it needs to grow and, of course, its cost.
The third element is value. How much is a business worth? From a strictly financial point of view, the orthodox way of calculating the value of a business is based on the discount of the expected cash flows. A business will have greater value if future cash forecasts are high and if the perceived risk is low. Forecasts for cash high and make sure u n business has a high value. The perception of risk materializes in the discount rate to be applied to said flows, a perception of low risk will be discounted at a lower rate than a perception of higher irrigation. In this way, all the fundamental elements of financial, cash, risk and value management are combined.
Finally, the director or owner of a company must constantly ask the right questions to manage finances and keep the answer up-to-date. These questions are:
– Cash. How much cash are we generating on a recurring basis and how much do we plan to generate in the next 5 years?.
– Risk. What is the perception, in the market, of the risk of my company?.
– Value. How much is my company worth?.
Naming and corporate identity by Little Buddha