The example in the article of how the restauranteur halved his food costs simply by pre-paying his supplier rather than paying Net-120 (120 days after goods are delivered) fascinated me. Where exactly does the value of cash flow come from?
Rehashing the example from the article:
Why do restaurants pay Net-120? Suppose Restaurant R is buying 30-day dry-aged steak from Supplier S. R needs to buy the steak days in advance of cooking it to serve customer C. R receives money for the steak only after this point, and now R can pay back S.
Why is pre-payment better? S can now be more efficient about the number of cows they have to slaughter. If R pays by Net-120, S ends up with a lot of waste due to unsold dry-aged steak, because S cannot anticipate the true demand but must be prepared to capture it to earn money.
Analysis:
In effect, S and R are pushing C to plan better. If C can just confirm that they want dry-aged steak ahead of time, which involves significant preparation, the entire supply chain can be more efficient. Sometimes, planning ahead is a benefit for C, as landing reservations at top restaurants can be difficult. Other times, C does want the ability to make last-minute decisions on where to go for food.
Meanwhile, S can do something better than slaughter the cows that would have gone to waste. In essence, S has more freedom because S has more cash flow. So does more cash flow == more freedom?
Cash is the most liquid asset. Supposedly, it represents the value that you can transfer immediately. I can have all the cash in the world, but if I am bound to pay a ton of debt with that cash, do I really have the ability to use the cash for something I value? That's why cash flow is a separate, and more useful, concept.
One argument against "cash flow == freedom" is that cash flow can be a function of effort. If I spend all of my waking hours working, I will generate cash flow, but I won't get to enjoy anything. What about landlords who don't have to do much to earn cash? Well, cash flow in strict $ terms doesn't capture everything. Businesses don't have this problem because they can simply capture the effort for producing cash flow in terms of wages. A simple trick is to pin a cash value for the amount of time I spend.
Cash flow represents freedom because cash flow = value in - value out at a given point of time. You don't even need to use USD for the "cash" part of cash flow, if that's not what you value. Then, to increase cash flow, you can 1) strictly increase "value in" (e.g. work more), 2) strictly decrease "value out" (e.g. delegate a task to free up your time), or 3) increase "value in" more than "value out" for a single transaction (e.g. take out a loan). Increasing cash flow doesn't need to be immediate: you can work on an asset and incur negative cash flow initially to establish better long-term cash flow. Worse "value in - value out" now for a better "value in - value out" in the future.
It's neat to see how to apply accounting principles to optimize my day-to-day.
Rehashing the example from the article: Why do restaurants pay Net-120? Suppose Restaurant R is buying 30-day dry-aged steak from Supplier S. R needs to buy the steak days in advance of cooking it to serve customer C. R receives money for the steak only after this point, and now R can pay back S.
Why is pre-payment better? S can now be more efficient about the number of cows they have to slaughter. If R pays by Net-120, S ends up with a lot of waste due to unsold dry-aged steak, because S cannot anticipate the true demand but must be prepared to capture it to earn money.
Analysis: In effect, S and R are pushing C to plan better. If C can just confirm that they want dry-aged steak ahead of time, which involves significant preparation, the entire supply chain can be more efficient. Sometimes, planning ahead is a benefit for C, as landing reservations at top restaurants can be difficult. Other times, C does want the ability to make last-minute decisions on where to go for food.
Meanwhile, S can do something better than slaughter the cows that would have gone to waste. In essence, S has more freedom because S has more cash flow. So does more cash flow == more freedom?
Cash is the most liquid asset. Supposedly, it represents the value that you can transfer immediately. I can have all the cash in the world, but if I am bound to pay a ton of debt with that cash, do I really have the ability to use the cash for something I value? That's why cash flow is a separate, and more useful, concept.
One argument against "cash flow == freedom" is that cash flow can be a function of effort. If I spend all of my waking hours working, I will generate cash flow, but I won't get to enjoy anything. What about landlords who don't have to do much to earn cash? Well, cash flow in strict $ terms doesn't capture everything. Businesses don't have this problem because they can simply capture the effort for producing cash flow in terms of wages. A simple trick is to pin a cash value for the amount of time I spend.
Cash flow represents freedom because cash flow = value in - value out at a given point of time. You don't even need to use USD for the "cash" part of cash flow, if that's not what you value. Then, to increase cash flow, you can 1) strictly increase "value in" (e.g. work more), 2) strictly decrease "value out" (e.g. delegate a task to free up your time), or 3) increase "value in" more than "value out" for a single transaction (e.g. take out a loan). Increasing cash flow doesn't need to be immediate: you can work on an asset and incur negative cash flow initially to establish better long-term cash flow. Worse "value in - value out" now for a better "value in - value out" in the future.
It's neat to see how to apply accounting principles to optimize my day-to-day.