Understanding Cashflow vs. Capital Gains

Part of being an entrepreneur is understanding the financial aspect of running a business. Being an expert in finances is not necessary as you can add team members who are experts to fill in the gaps for you. Knowing the basics and understanding the rules are important in order to develop your business, your business strategy and your company’s identity.

Vocabulary Defined

Asset: Simply put, an asset is something that puts money in your pocket every month.

Liability: A liability, on the other hand, takes money from your pocket every month.

Cashflow: This is the amount of money flowing into the business every month. Focusing on increasing the company’s cashflow is key to growing the business. Buying assets with positive monthly cashflow will increase the company’s overall cashflow.

Capital Gains: Capital Gains can be defined as the profit from selling a house that has appreciated, or when stocks go up, the amount it went up is the capital gains. In other words, this can be risky in that you or your company are buying something expecting its value to increase.

Cashflow and Why It Is So Important

The service industry is tied directly to monthly cashflow. In a small business, when a contract is signed with a set total amount, there is a sometimes a retainer fee and then a payment plan in place that matches the length of the project. So if a small business has ten clients each paying monthly, the cashflow might be pretty good. However, when clients stop paying, or when those projects end and no new clients come in for a month or two, the company can take a turn for the worse very quickly.

The Service Industry Swings Up and Down

That’s just the way it is

A lot of times I hear that the service industry swings up and down and that that is just how the business is. My immediate thought is, what?! You mean to tell me that there is no way to change that, or hedge against that in order to create a more steady monthly cashflow?

It is true that the construction industry and other industries dependent on the construction industry swing up and down larger than other industries.

Yet, there is a simple way to hedge against these swings. That way is by adding more lines of business, or revenue models. The main business may be services, but what about creating online products that compliment the services provided?

The information product industry is a great example of services that are turned into products. From one talk, there are multiple ways to re-package and resell it. Think about it. The audience pays to hear the talk live. People who couldn’t attend the talk can download the audio for $x online. Want the live Q & A portion not offered in the audio? You can buy the DVD with behind the scenes and never before seen footage. You can also sell the transcript of the talk as a PDF download. Right off the bat are four other ways to resell one speech.

So let’s recap. Your company provides services and one form of services (and marketing) is to give keynote addresses, workshops, seminars, etc. From those speeches, there are at least four products from that one speech. Five revenue sources total. This may account for a small portion of the company’s revenues, but as that part of the business starts to grow, it will account for more and help to offset the direct services business line.

Why is this so important? As a service business, if you are solely dependent on only providing services, you may at some point get stuck. Especially as a small business, it is extremely easy to get stuck when things get slow. However, with other revenue models in place, they can offset other business lines and help to keep the swings more shallow rather than scaling up and down so radically.

Capital Gains Is A Form of Gambling

Capital Gains looks at the short term sides of things. If you buy X and it increases in value, then you make Y.  However, most things are not guaranteed to go up in value. Sure, it would be great if everything we bought would appreciate in value. In fact, the very opposite is true. Most, if not all of what we buy as consumers, go down or depreciate in value. Why? A new version of the same product will be released, thus, devaluing the previous model.

The same is true with money. The U.S. dollar is a currency and designed to lose value over time. Inflation is what causes the dollar to “increase in value.” Yet, because of inflation, material things cost more money. It is not that anything actually costs more, it is that the dollar is worth less. Especially in this economy, as the Federal Reserve is printing more and more money, the dollar is losing value more quickly. In order to stop that, inflation occurs, which makes everything go up in price.

Understanding this, when you look at capital gains, it is a form of betting. You are betting, subconsciously or consciously, that a stock will go up in value, that the price of a barrel of oil will go up, that houses will go up. When they do not go up, when the housing market crashes, it proves that it was a gamble.

Capital gains is not all bad, it should just not be the end all. Capital gains plus cashflow will provide for the best foundation.