Key Insights from Finance for Business Owners, Managers, and Investors

Introduction

• Overview of 5 big ideas in finance to help improve business understanding and decision-making.

Finance Idea #1: Profit vs. Cash Flow

• Concept: Profit is not the same as cash flow.
• Example:
  • Inventor hires manufacturers and retailers.
  • Purchases 100 units at $80/unit, sells 50 units at $100/unit.
  • Revenue: 50 units * $100 = $5,000
  • Cost of Goods Sold (COGS): 50 units * $80 = $4,000
  • Profit: $5,000 - $4,000 = $1,000
  • Cash Flow:
    • Cash In: $0 (payment from retailer after 30 days)
    • Cash Out: $8,000 (paid supplier on delivery)
    • Total Cash Flow: -$8,000
• Conclusion: You can be profitable but still have negative cash flow, leading to bankruptcy.

Finance Idea #2: Financial Statements Tell a Story

• Balance Sheet: Overview of assets (what we own) and liabilities (what we owe).
• Income Statement: Revenue minus expenses = profit or loss.
• Cash Flow Statement: Depicts cash movements over a specific period.
  • Balance Sheet: Snapshot at a point in time.
  • Income Statement: Performance over time (movie).
  • Cash Flow Statement: Documentary of cash movements.

Finance Idea #3: Book Value vs. Market Value

• Book Value: Worth on paper based on historical data (balance sheet).
  • Example: Apple Inc. book value around $106 billion; book value per share = $22.55.
• Market Value: What investors are willing to pay based on future expectations.
  • Example: Apple's share price in May 2019 = $200.
• Conclusion: Book value reflects past performance, while market value reflects future potential.

Finance Idea #4: Driving Operating Income

• Cost Cutting: Common focus but not the only option.
• Pricing Strategy: Reflect value created for customers.
• Sales Volume: Explore opportunities to sell more units.
• Product Focus: Prioritize higher-margin products/services.
• Resource Efficiency: Generate same output with fewer resources or more output with the same resources.
• Supplier Negotiation: Renegotiate contracts for better pricing.
• Spending on Development: Invest in R&D, marketing, and employee training to enhance product/service value.

Finance Idea #5: Time Value of Money

• Concept: $100 today is worth more than $100 one year from now due to various risks (e.g., inflation, bankruptcy).
• Example:
  • If offered $100 today or $105 in a year, the present value equals future value.
• Application: Important in evaluating investment proposals (net present value, internal rate of return).

Conclusion

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