Entrepreneurship 101

Fred Wilson explains how to run a business:

Let me explain. Businesses are worth the net present value of future cash flows. Cash flows means profits basically (capital expenditures are important but I’m going to leave them out of the discussion on this post). So a business is worth the sum of all of its future profits, discounted back to a net present value. For those who don’t want a lesson in finance, you can simplify this theory even more by using a cash flow multiple as a proxy for a net present value. I like to use a 10x multiple for cash flow as a simplistic proxy for net present value.

So with that simplification, the value of a business is approximated by 10 x (revenues – costs). You can focus on creating value by driving revenues or you can focus on creating value by driving profits. And they are not the same. Because costs don’t have to grow linearly with revenues.

The bottom line is that successful businesses need positive cash flow. Anything else is a shell game of sorts. Sometimes you can get people to give you money by way of debt, acquisition, private investment, or public stock offering on the promise that positive cash flows are attainable, but positive cash flows are always the goal. In a crappy economy, it’s tougher to convince people to bet on the future, so the goal has to be positive cash flows right now.

By the way, positive cash flow is the key to personal finance as well. Ever meet people who make lots of money but feel like they don’t? It’s because they aren’t managing their cash flow very well.

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