Managing Cashflow

Cashflow is a fundamental item for any business, any family and any government to manage. Warren Buffet once said that there seems to be some perverse human characteristic that likes to make easy things difficult. Cash flow is one of these areas. My homespun thoughts on cashflow are pretty universal to everything.

Within every dollar of revenue, there will be direct costs. The family will need to eat and have a roof over their head. A business will need to pay staff and for inputs to produce whatever it is that they produce. A government needs to support those who cannot support themselves and provide the infrastructure, support the energy, manage the health and education networks and generally provide the environment for the society to prosper.

Over the longer term, the revenue needs to match or exceed the costs or there will inevitably be a problem.

Excess revenue provides choice. How choice is exercised is up to the individual. Many individuals we speak to are both seeking advice about the discerning costs that they must incur and the discretionary costs that they choose to incur.

I use a basic rule of threes as a "guide" to how to manage household budgets, business budgets and argue it would equally apply to government budgets if we could just speak plain english rather than smoke and mirror ideologies.

It goes like this. When designing the budget/business/family calendar, you ought to allocate 1/3 of your resources to taxation. (This is simple - of course everyone's situation is different and dependant on lots of complexity so does not represent tax advice!) 1/3 of family resources will be spent on consumption. The remaining 1/3 will likely be consumed by debt (mortgage)/Schooling/Investment/Choice. The last third will depend on stage of life, size of home, type of schooling for kids and other decisions the family will make. Having a firm eye on cashflow would guide where responsible limits will be to prevent poor decisions. We find these things are often only considered after the event rather than before. Many self employed spend the money then struggle with the taxation at year end for example.

In business, we talk to many businesses about capital management which can apply the rule of 3's from the point of determining profit levels into 1/3 taxation, 1/3 return to owners and 1/3 capital reinvestment into the business which could be either reducing debt levels or building up balance sheet strength to chase future opportunity.

It seems to me the current policy debate in federal politics can be boiled down to a desire on one side of politics to be a bigger government with more projects and more tax to pay for it versus the other side of politics who prefer a smaller government with less ambitious projects and less tax required to pay for it. The emotion that is attached to the policy debate is unhelpful. The track record of delivery of projects between the private sector and the public sector is up to citizens to make their choice. My two cents is that there will always be things that are good for society but are not commercially viable for the private sector. For society to function, government needs to step in. When you look at security of power through this lens, the answers I think become very transparent. How many projects and what cashflow is required to fund is then a matter of mathematics.

To close this discussion out, remember balance sheet movement over time is sanity, profit and loss is vanity and cash is king.

Taken one by one - which is balance sheet movement sanity? Balance Sheet movements are the movement in the market value of assets in proportion to the market value of liabilities over time. If you run a break even scenario, over time, inflation will inflate the level of assets and improve the balance sheet. Time can heal mischief and repair balance sheets.

Profit and Loss otherwise known as statement of financial performance is vanity. Why - The revenue less cost of goods sold less overheads comprises the statement of financial performance. Financial performance is often obscured by capital items such as stock or depreciation of capital assets that means there is management judgement about the treatment of items that impacts which period in which the activity is brought to account. This ability to move results between periods results in my throwaway line about vanity.

Cash is king. It does not lie. If you consistently spend in real dollars money you have not received your debt will go up until the financier decides not to support you anymore. The music stops and you have to pay it back, after tax. The 2007 global financial crisis was a good example of what happens if fear takes over in relation to debt levels. That has not yet played out in full, merely been kicked down the road a bit. It will resurface at some point. Spending less cash than you acquire will result in an increase in the choices that can be made in the future. Spending more cash than you acquire will result in a decrease in the choices that can be made in the future. The barefoot investor says to "choose your path". I just say, "Have your eyes open when you make your choices. You can only spend that dollar once!".

I hope this has been useful.