Who controls the past, controls the future. Who controls the present, controls the past. Money is the link.

Money is the denomination of the numbers side of Business. Business boils down to numbers. Here is a quick summary of the big picture of the numbers side.

Money in Business is what we count and keep track of first and foremost. Its how we keep score. Money is what we measure, and what gets measured gets managed.

If your output is more than your input, your upkeep is your downfall.

A successful business model is all about making more than you spend. Even if you are losing Money with a strategy of gaining market share, the present value of that increased future market share needs to be more than the dollars you are spending today to capture it. That is the only rationale that makes economic sense.

Corporate Finance

Corporate Finance, in its broadest sense, encompasses everything that has to do with Money in Business. It includes accounting, funding, spending and investing in assets, and budgeting.

Accounting

Goethe rapturously described accounting this way:

“Double entry bookkeeping is one of the most beautiful discoveries of the human spirit.”

Accounting produces Financial Statements. There are ten steps in the accounting process. The process starts by recording individual transactions and ends by aggregating all the transactions into Financial Statements.

Funding

Funding has to do with the right-hand side of the balance sheet: debt and equity. Debt, also called a loan, is Money you borrow with a contract to pay it back and collateralized by the assets. Equity, also called stock, is Money invested in exchange for an ownership share in the company.

There are straight debt and equity and lots of hybrid financial instruments that mix the two. There is senior and junior debt depending on the claims on the assets. There is debt that is convertible into stock, and you can have common and preferred stock.

These instruments are all negotiated with investors and bankers, and they are used to acquire the assets listed on the left-hand side of the balance sheet.

Discounting Cash Flows

There is a time value to Money. A dollar today is worth more than the promise of a dollar two years from now. The time value of Money manifests as interest rates.

That is what an interest rate is. An interest rate is an amount an investor requires to use their Money and compensate for time and perceived risk.

Time is Money.

Corporate Finance tools calculate the present value by discounting future cash flows. I’ll talk a bit more about this in the Future section below.

Investing

In Business, you need to know which income-producing assets to purchase and which projects to pursue. Financial decision-making tools like NPV and IRR analyze and measure value. They are valuation techniques.

Finance is all about the sources and uses of funds and keeping track of how those decisions are performing.

The Past

Accounting and Financial Reporting are retrospective activities. They provide a detailed account of what has happened. It’s the equivalent of a rearview mirror.

Ratio Analysis

Ratios are a way to compare accounting information. It can be over time or across companies. Ratios gauge performance by comparing if the numbers are getting better or worse. Ratios help you uncover the direction things are going.

Horizontal ratio analysis is over time. Vertical ratio analysis is comparing one company to another. Using ratios normalizes the numbers, so you are comparing apples to apples. It eliminates size differences.

What gets measured gets managed.

Measure what matters.

The Present

Current financials represent a picture of where the company is today. It’s a picture of how the company has performed in the most recent reporting period. Financial statements and reporting is how the present connects to the past in Business.

Financial Statements

There are three primary financial statements:

Balance Sheet

Income Statement

Cash Flow Statement

They are interconnected, and financial data and information flows from one financial statement through the others.

The present connects to the future in Business through interest rates or discount rates. These take into account all the uncertainty and risks inherent in the Business’s prospects.

“The importance of money flows from it being a link between the present and the future.”

— John Maynard Keynes

The Future

Financial Projections are the best guesses about what the company is going to do and how it will perform going forward — this view is equivalent to through the windshield.

Pro Formas

We call Financial projections “pro formas” because they are presented “in the form of” financial statements.

Valuation

We use discount rates to discount future cash flow projections back into today’s dollars. The Present Value of Future cash flows is essentially the valuation of the enterprise or the income-producing asset.

In publicly traded stocks, the present value of future cash flows is being guessed at by all the market participants for that stock. Stocks are bought and sold in an auction format based on investors’ guesses of the present value of the future cash flows.

Budgets

Yesterday’s tomorrow is today.

Budgets are the best guesses about how much Money will come into a company through sales and how much will go out via expenses. We make Budgets to estimate and anticipate revenues and costs for the next year.

Publicly traded companies call these estimates “guidance” when they announce them to investors and analysts each quarter.

As the year unfolds, we compare Budgets to the actual revenues and expenses. Any differences (called variances) are then examined and explained.

Budgets, actuals and variance analysis comprise a basic management technique.

For all the above reasons and examples, Money is how we keep score in Business. Apply the same skills to manage your budget and lifestyle. After all, you are a business.

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