Hello. Welcome back to Part Two: Delivering Ideas, and this is Tool #7. It's called Tracking the Money. How do you keep track of money coming into your company, hopefully, and the money going out? And of course it's about how we crunch the numbers and how we do our accounting. Text books on accounting are thick and perhaps a little boring. I think I can try in five or six minutes to try to give you the basics, plus an important piece of advice that I hope you will follow in depth. That has proved itself. So, how do you track the money in your business? How do you keep track of the money going in and money going out? This is related to your business plan. So your trying to take your idea and make it into a practical business and part of doing that has to do with expenses and revenues and my point is going to focus on something called cash flow and I'll explain what that is and show you how to make use of that in your start-up business. There are several ways that you can start a business. You can come up with an idea and as you see on your screen, write a business plan and create a profit and loss statement as part of the business plan and then seek an investor. I often advise my start up students and young people after they come up with an idea, to think about bootstrapping their business. That means, try to get the business going with minimal funding, mostly funds that you raise from yourself, your savings, perhaps even your aunt or your uncle. I know a lot of people who say this is an absolute no, no. You never take money to start a business from family because it's so risky. And often they might not really understand how risky it is, and how big the chances of failure, but nonetheless. Food for thought. See if you can bootstrap your business based on your own funds, without raising funds, and then if you have the business plan in your mind, I tell my students to do a non-business plan. What's a non-business plan? A non-business plan is action rather than a piece of paper. Get out and do ten things a day that you need to get your business started to move ahead. Talk to customers, find a strategic partner, do market research, do an industry analysis as we explained, Michael Porter's tool, do some marketing, do a marketing plan, do a prototype, very important. And then see if you can get a product out there that generates some early cash flow because if you're boot strapping, you're quickly, quickly, running out of money and that does create a sense of urgency that gets you to create a product and sell it, and then you get a lot of valuable information from people who actually use it. The best part is, if you bootstrap your business you retain 100% of control. If you raise money from investors, they can quickly, after rounds of funding, quickly get over 50% of the shares and then they decide and sometimes you can find yourself being removed from the company because the investors want a responsible adult to run it and I've seen that happen more than once. So let's go on to the main point, before we tackle our five minute vest pocket presentation of accounting. The human body needs blood and it needs oxygen. We have blood that the body manufactures, we breathe oxygen from the air and our lungs provide it to our body. The oxygen of a business is money and when you run out of oxygen you have no business. So treat every dollar with huge respect just like we treat the oxygen, the air we breathe. Even if you have quite a lot of money, you still need to treat every dollar with respect. If you have very few of them, make sure that you spend your dollars or your euros with great care and with great caution. I think that's the essential lesson of accounting. Tracking the money is designed to make sure that every single dollar we spend, is spent on something vital, necessary, and productive. No wasteful spending, especially in a startup, where every dollar is so important. Later when you have an established business and you're making great, great profits, you can think about fancy offices and cars and so on. And even then, it's probably not too good an idea. And I'll tell you stories, tragic stories, about great companies who fail, because they haven't treated their money with respect and used it properly. Vest pocket lesson on accounting in one slide. There are three accounting statements that you need to understand. A balance sheet, an income statement, sometimes called a profit and loss statement, and a cash flow statement. The balance sheet and the income statement are widely used and studied. The press talks about earnings per share all the time, which comes from the income statement or the profit and loss statement, P&L sometimes for short. We often don't hear about cash flow, but especially in a startup the cash flow statement is the most important. So what is a balance sheet? A balance sheet is a snapshot at a point in time, often the end of the year, December 31, showing first of all the assets of a company. What are your assets? What do you own? o-w-n. And what are the liabilities of the company? What do you owe? o-w-e and the difference between what you own and what you owe is called share holders equity. It's essentially the net worth of the company as accruing to the share holders. It's like a house. If you have a house worth a million dollars and you have a $500,000 mortgage, so your net worth or your equity in the house is a million minus 500,000. Accounting is based on double entry bookkeeping, that was invented a long time ago, brilliant invention. Every transaction has two sides, both sides are recorded and a balance sheet always balances beautifully. The income statement is a flow, it's not a snapshot at a point in time, it's a flow of money going in and out over a period of time three months usually or an entire year and includes revenue minus the cost of producing the goods, the fixed costs, the interest payments and then the net profit, how much is left after we've deducted are costs. And how much profit is there per share, called earnings per share, that investors and financial analysts track very carefully. The third statement is the cash flow statement. And the cash flow statement is illustrated by my friend, my guest lecturer that I've invited here The piggy bank, it's actually a cow bank. One of my students politely pointed out this is not a piggy but a cow. And the cow is really simple. It's a bank where you put money in, and then when you have to pay your salary, you take many out. And, every morning in your start up business, [SOUND] you shake mister cow, and you ask yourself, do I have any money left? And, heaven forbid if you shake the cow and there is no money left, essentially you're out of business. And the piggy bank is how we do the cash flow statement. It's simply the money that goes in, and the money that goes out and it's real. It's nothing that is invented or fictional. So the balance sheet is what you owe, what you own, and the difference. The income statement, as you can see on your screen, is your sales revenue minus the cost of good sold. Minus depreciation, which is what the tax laws allow you to deduct as a business cost. Because you have equipment and cars and computers, and they're losing value over the year. The depreciation often has nothing to do with the real loss of value. Earnings before interest and taxes, minus interest, taxable income. You deduct corporate taxes, and you get net income. Which you pay out either as dividends to the shareholders, or you keep in the business as retained earnings. That's the income statement, or the P and L. And you need to know what a balance sheet and an income statement is. In a very early stage of your business you'll need to have such statements, especially if you have issued shares. [COUGH] But I want to focus on what I think is much more important on the cash flow statement. The cash flow statement is real, not fictional. For example, depreciation in the P and L, the profit and loss statement. Depreciation isn't real in the sense that you wanna deduct as much as you can, as depreciation to lower your taxable income. And you do that according to tax law, and it really isn't related to the actual using up or obsolescence, of your computers and your assets. But cash flow is real, because it's the real recording of every dollar or euro that comes in and goes out. So a cash flow statement is divided vertically and horizontally. It's divided between plus, money coming in. And minus, money going out. And it's divided horizontally between cash flow from operations, hiring people, buying equipment, selling stuff, and so on. Operations, and cash from investors and finance. Borrowing from the bank, selling shares to a venture capitalist, and so on. And then money that we draw to pay back our debts, as negative cash flow. So positive cash flow is plus money coming in. Negative cash flow is minus. Some of the cash flow is on daily operations, and making and selling our product. Some of it has to do with financing, money, shares, bonds, interest, debts, bank loans, and so on. And of course, we have a net number, that's the piggy bank number. How much do we take out of the piggy bank, how much went in to it, and what is the net cash flow. When you start a business, a lot more money goes out as minus, then comes in as plus. That's why there's such great urgency in a startup. To make a product or a service, get it out there, start to sell it. A, so that you get incoming cash flow. And B, so that you learn about the product from your customers, so you can improve it and make it better, and adapt it to the needs of your clients. The lesson here is, manage your business by cash flow. Not by the profit and loss statement. Let the accountants do that. But you check your cash flow every single day. Have that cash flow statement on your desk as the founder. Check it out. What's your burn rate? How fast are you using up your cash? How many more days can your company live, before you're out of business cuz you have no more oxygen. Your blood has been drained from the body of your company. Manage by cash flow. Get yourself one of these things. Get yourself a cow bank or a piggy bank. Put it on your desk. Check it out every day. Check out the cash flow. And that will give a new urgency to your business, which I think in general is very healthy. There are sad tales about companies that failed to manage on cash flow, and that failed to disrespect their money. I used to be academic director of the Technion Institute of Management. We had a little office in a science park in Tel-Aviv, right in the midst of startup companies. I used to look out the window and I would see car carriers. And the car carriers were bringing new cars for the startup people, because the startup had just gotten an injection of capital from an investor, a venture capitalist. And they were buying cars for the workers. You have to attract talent, right? You have to offer them benefits. So they were offering them company cars. And as I looked out the window time passed. And six months later the car carriers came back, and this time they were empty. And they were loading the cars back onto the car carrier, and taking them back to the company. Why? Because the startup had gone broke. Why did it go broke? Because cars are not that productive a use of cash. You need to invest your cash in marketing, in selling, in developing your product and educating the market. In top, high priority things. Treating your cash with great respect. So there are often sad tales of companies that disrespect their money. Some of you who maybe have grey hair, a few of you, may remember a wonderful product. A spreadsheet sold by a company named Borland, called Quattro. A really good spreadsheet; the best spreadsheet at the time. Before Microsoft Excel. And Borland built a brilliant, beautiful headquarters building in Silicon Valley, up on a hill. And as you've drove down on the main road, from San Francisco to Los Angeles you could look up and see this castle on a hill, built with Borland money and a brilliant entrepreneur named Philippe Kahn. But that castle on the hill was a big problem. Because instead of putting the money into developing new and better Quattro Pro spreadsheet software, it went into that building. And one by one, the lights in the building started to go out. And today no one has heard of Quattro, even though it was originally a market leader. I think they disrespected their money, and failed to put the money into productive uses. A building usually is not that productive. New products, innovation, R and D, that is definitely productive. So, what can you learn from cash flow statements? You can learn answers to some important questions. Cash from operations, are you generating an inflow of cash? When will you have an inflow of cash? When will your product get to market? And at what point will your cash flow become positive in a net sense, so your piggy bank is filling up, when you shake it, it makes more noise rather than less. How much cash are the owners drawing on operations? What are you drawing as a salary? In an early stage of a start-up you have to draw the absolute minimum just to sustain yourself. How much cash are you getting from operations? How much cash are you getting from financing, from the lower part of the cash flow statement? How much cash comes from debt from borrowing, and how much from equity, selling your shares? Perhaps doing an initial public offering of shares. What's your burn rate? What's the rate of which cash is flowing out, and how long can your survive with that burn rate? And, how can you lower the burn rate, so you increase the life expectancy of a company. All of these are questions that can be answered with a cashflow statement. And this is a true story, I once knew a start up company. A boot strap company, and they had a clock on the wall. But the clock didn't tell the time. The clock said how may more days until our money runs out, and of course everybody could see that clock. That will create great urgency in your company. Consider creating a cash flow clock. How many more days until we run out of oxygen and we no longer exist? So this is very hard for you to read on your screen. It comes from a business plan, I mentioned this business plan earlier. It's the business plan that started a great global market leader in firewall protection company called Check Point originally in the business plan called NSK, after the frist initial of the last name of the three founders. And in this business plan, as an exhibit they have a budget. And for two years or three years, and for the first year quarter by quarter they have done a detailed description of all the expenses that they expect to encounter. And those expenses involve developer's salaries, costs, R & D, capital expenses, work stations, sales, general and administrative. All of these things done very carefully quarter by quarter as a sample budget. Some of this probably came true, some of it may not. But the point is that the start up people the entrepreneurs have shown their capable of doing a budget. They know how they would use the money they need to get their business going and they know how to treat money with respect and how to track it, and how to budget it. Make sure that they know how every dollar is spent, and make sure that every dollar is going to where it's really needed rather than wasted. Another quick, very small story before we do our action learning exercise. I have an acquaintance, a famous Israeli entrepreneur, who started a great company, did an exit, sold the company, made a great deal of money, and I mean a great deal of money. And instead of retiring forever as many of our entrepreneurs do, started another company, and then another, and another. And I once interviewed him by email. He answered my questions while on a flight to Japan, a business flight, and he flew economy class. And he's a tall person so he was crammed into a very small seat. And I asked him, good heavens, you can afford to buy the plane, why are you traveling economy class? And the reason he gave was very clear and worth remembering for my students. He said, I wanna show my investors that I'm treating their investment dollars in my company with great respect. And that's an important lesson, treat your cash with great respect. Meaning you use the cash in ways that are productive rather than unproductive and you do that by tracking your cash flow statement, regularly checking it, and making sure that what you spend is necessary. So, test your understanding. Do you know what a balance sheet, P and L, and a cash flow statement, you know what they are, how they're connected? Why is the cash flow statement so crucial? What are the two types of cash flow? What's the burn rate? These are all basic and important things to understand as you create your startup. And finally, action learning. So here's what I'd like you to consider doing as action learning for your idea. Try to crunch the numbers for your idea, as difficult as that may be. How much money will you need? How much will you need for advertising, R&D, management, marketing? Marketing's expensive. You may not have money for marketing. How will use your money? Can you create a budget? How long will it take for you to generate cash inflow? When will you get some revenue? And how long will it take for you to become cash flow positive? More money is coming in than is flowing out. How can you minimize your burn rate? How can you get to market really quickly? Can you have a business that survives the cash outflow, the negative cash flow until you finally get some cash flow coming in? Can you survive the inevitable period of bleeding or lack of oxygen. That ends our discussion of cash and we're next going to discuss a related tool, tool number 8. Risk. How you manage risk.
