4.3: Measuring Your Success
When is this going to make money?
In the typical business world, profits are the ultimate measure of success. Investors look to the financial statements to find the story of how the company performed. Projected financials are also important. If you don’t know how to create financial statements, ask a business major or accountant to help you.
Cash is king
For a start-up business, or any business, having cash when you need it is crucial. In fact, many profitable businesses fail because they grow too quickly and run out of cash along the way. You could face this problem too if the payments to your suppliers are due before you get paid by your customers. Predict the timing of your cash inflow and outflow, and make sure you have the cash to cover yourself when you make decisions.
In operating your company, keep close track of your cash position. While you’re working to make your venture viable, you should probably estimate your cash flow on a daily basis. The term burn rate refers to how quickly a company is using up its available cash. If you don’t have a perfect picture of how you are using money, estimate your burn rate to determine how many days you have until you need more funding or have to cease operations.
Your original business plan might include a rough cash flow estimation. Your financiers will use it to determine when they will begin getting a return on their investment, and how high the return will be.
The balance sheet reports the position of the company at a point in time. It is divided into three parts: assets, liabilities, and owner’s equity. Assets represent everything of value in the firm, such as property, inventory, cash, and payments owed by customers. Typically the assets are listed in order of decreasing liquidity, meaning that the ones easiest to convert cash are first. Liabilities represent debts owed to customers, employees, and banks. These are listed roughly in order of when they come due. Owner’s equity is what’s left over when liabilities are subtracted from assets. It’s the value of the owner’s (or stockholder’s) share of the company if it were to cease operations. The actual value of the company is based on its future potential (and should be higher than owner’s equity on the balance sheet).
The income statement reports the revenues and expenses of the company over a specified time period, culminating in a profit or loss. Income is reported based on accounting rules and often does not reflect cash changing hands. Revenues can be reported when a product is sold and delivered to the buyer even if they have not paid (but will pay in the future). The income statement also follows the “matching principle,” which requires expenses to be matched to revenues and reported at the same time. This means that expenses incurred to produce a product are not reported in the income statement until that product is sold.
The cash flow statement documents the sources and uses of cash over a specified time period. Each activity where cash is gained or lost is listed, along with the amount. The activities are typically divided into operations, investment, and financing. Positive cash flow from operations is a sign that the business is making money from the goods and services it’s selling. The investment section documents cash used to purchase assets or gained in the sale of assets. The financing section represents cash borrowed from banks or gained through the sale of stock, and cash used to pay back loans or repurchase stock.
More than one bottom line
You and your investors may want to achieve other returns on your venture. Again, we’re referring to the triple bottom line. While the first bottom line, profit, is shown in your financial statements, you must create metrics to report your other bottom lines (see the sidebar on the bottom left). Committing to goals that improve the environment or the human condition should be coupled with establishing a system to track your progress. It’s difficult to see how far you have come if you don’t have consistent ways to measure your impact.
The National Social Venture Competition recommends two different options for quantifying social impact in dollar terms. One, based on project valuation techniques at the International Finance Corporation, involves thinking of the best alternative solution that exists to meeting the social need you are tackling. To find the monetary benefit of your method, subtract your expenses to meet this need from the expenses that would be incurred if the alternative solution was used instead. The second is based on the approach used by Roberts Enterprise Development Fund to value its social venture returns. The monetary return is calculated by adding the savings to society (in governmental program costs that do not have to be spent) and the gains to society (in tax revenues) from your work, and subtracting your business expenses that are related to implementing the social purpose (and would not be otherwise incurred).
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The Inexact Science of Social Return on Investment (SROI)
Social Return on Investment (SROI) measures social impact in dollar terms. Whereas financial return is relatively straightforward, differences in personal values and definitions of “social impact” require varying measures of social return. In fact, many social returns are impossible to quantify, making this a necessarily inexact science. SROI can be thought of in terms of jobs created, houses built, or lives saved. But to start a social venture, you need to come up with a model to measure your particular social impact. A working SROI model helps investors determine the attractiveness of a potential investment. Documenting meaningful social returns is crucial; without an understanding of the tangible and measurable effect created through an investor’s activity, the reasons to engage in this critical work are merely anecdotal.
Developing a cash flow budget
Here are some steps you can take to create a cash flow budget you can rely on:
From “Financial Troubleshooting,” Inc. Magazine, August 2000, by Michael Pellecchia |