Literacy has an expanded meaning, and it determines how successful you can be as an entrepreneur. Financial literacy is about managing your knowledge of money matters. It is not what you own or earn. It is about looking at your financial commitments and resources and optimising them.
Jerry launched a promising food delivery startup but had little financial literacy. He mixed personal and business money, never tracked cash flow, and relied on gut feeling instead of basic projections. Within a year, he underpriced services and ran up high-interest credit card debt. When inflation spiked, he had no reserves or clear picture of his break-even point. He missed loan payments, damaged his credit score, and was forced to shut down just as demand was growing. Only later, after learning to read financial statements and build a simple budget, did he see how avoidable his collapse was.
What does financial literacy mean?
Knowledge about money and decisions about consumption, saving and investment in a basic sense is not taught in our schools. While you might learn about financial management in relation to business, it is seldom about you, the entrepreneur. Since you are making the key decisions, the emotion sometimes gets in the way of numbers. Even in business, entrepreneurs often leave financial information on the side and follow their feelings. While intuition is helpful in situations of high uncertainty, and projections into the future can be murky, it should not be a rash choice-making process.
In our case with Jerry, he hoped for a better situation and did not know his breakeven point. With little reserves, he ran out of cash when inflation reduced his cash flow. A helpful tool is doing a forward cash flow for one year. This projection could point out what the consequences would be if a negative event pops up. Do you have the reserves to be resilient? In Jerry’s case, he relied on his credit card, which carries a high interest rate.
You do not have to be a stock market guru or a financial expert. You need to know about the flow of money and its timing. Making informed decisions about saving and investing. Anticipate what the impact of your decisions will be on the flow of money. Often, we see a rosy inflow and underestimate the negative things that could arise. If money is a tool, financial literacy is knowing how to use that tool without harming yourself.
Money learning
Savings are a surplus that every business should have. Retained earnings are a cushion for contingencies, delayed receivables, or a sudden expense. But it could also mean an unexpected opportunity; you get some forex to purchase, and you must buy it now.
Investing in your venture can be complex. This can be so for capital projects. If you need to analyze its financial impact, there are several tools available online for free. One simple tool is breakeven analysis. This is the point where your sales and expenses are equal. If you are making wheelbarrows and your unit breakeven is 1,000 units, you know that profits will be incurred after that level. If your fixed costs (plant and equipment) are high, it makes sense to use marketing to increase sales and maybe your unit fixed cost will decline. It is understanding your cost behaviour that should guide your decision-making.
There are other tools for analysing the purchase of, say, machinery. Payback period is the monthly benefit divided by the capital cost. A simple ROI is the monthly benefit from the machine multiplied by 12 months over the capital costs. While there are others, these are some of the simplest tools that can be done on the back of an envelope.
One blind spot for many entrepreneurs is the cost of capital for the venture. Psychologically, we often ignore or misjudge things of importance. The cost of capital is the minimum your venture needs to earn a profit. This can be a combination of borrowed funds and equity investment. If your bank will lend at 10 per cent, and this is the only source of investment, then that is your capital cost. However, investors, including you, have alternatives for your money, and this opportunity cost will set the bar. You may end up using a weighted average of debt and equity to estimate your cost of capital.
Family businesses often have a lower cost of capital, and they have interesting ways to lower it. They invest with a longer time horizon, way beyond the normal five to seven years for large capital projects. It is more like generational investing, and this longer period of payback puts less financial strain on the business as it does not have to show an early return, like venture capital.
Cash monsters
Look out for the cash devils. These can be bloated inventory that takes up space and has funds locked up. It is better to sell it at a discount and invest it in higher-profit items. I know of a parts retailer that held on to components for a declining vehicle population, and it had to sell them as junk.
Generous credit to customers can make them less profitable. Sometimes we are afraid to call and collect. Being shy can be costly. Some buyers are really “jay customers”; they are on the wrong end of the consuming street. They cost more to service than the benefit.
Underpricing items can mean less cash flow. Many times, costs change, and you may not redo the inputs, and your margin can shrink. With services where the margins are theoretically high, you need to settle for a base price of your time and vary it depending on the expertise required.
Personal withdrawals from the business can burden the working capital. Treating the firm as an ATM means there is no policy on salaries and dividends.
Money management is like gas in your car. Your vehicle holds a fixed amount, and it travels on that tank. You can fill up (cash) by selling to customers and keep on driving. However, you must use it wisely, so your cash vehicle is efficient. On the other hand, if you run out of gasoline, your business will cease to exist.
Sajjad Hamid is an SME and Family Business Advisor as well as a Fellow of the Family Firm Institute. He can be contacted at entrepreneurtnt@gmail.com
