Financial freedom for business owners never happens by chance. It is something that needs to be planned. Keeping track of how your assets grow over time is essential for your financial freedom.
Assets accumulate over time and the goal of the entrepreneur is to accumulate enough assets so cash is pumped into the business without little effort by the entrepreneur. This is where financial freedom happens.
Financial freedom for business owners: Financial freedom cycle
The financial freedom cycle is the flow of cash that begins with payment for assets and ends with receipt of cash by the owner. The financial freedom cycle illustrates the amount of time cash is tied up in the asset development and sales process before it is converted into cash the business owner can use to support his lifestyle. In other words, how much time is needed to generate revenue from assets, assets to profits and profits to cash. This cycle is broken down below:
- Business owner starts by investing cash into the business. The owner might invest in a product or assets needed to provide a service.
- The product brings more cash into the business in the form of profit.
- The profits are reinvested in the business either by buying machinery or hiring labor that can increase production.
- This increased production brings more profit
- Some profits are withdrawn by the owner as re-payment for taking risks
- The business owner invests this cash into other assets to increase future cash flow.
The goal of a business is to build up assets so work done today keeps accumulating wealth in the future. The key question here becomes, how do you capture that wealth? In other words, how do you keep from investing all cash into the business rather than saving some to take care of the entrepreneurs. A business will eat all resources you throw at it. So, you have to be very careful about resource allocation.
Financial freedom cash flow cycle
As mentioned earlier, the financial freedom cycle still generates income over multiple periods. The more work you do today, the more benefits you can reap in the future as shown below:
To enhance the benefits of cash received, it is best to reinvest the cash withdrawn. As a result, you see your finances grow exponentially.
Financial freedom cycle and the cash flow cycle
The financial freedom cycle is very closely tied with the cash flow cycle of a business. A business owner creates or purchases assets. These assets are either prepaid or paid within 30 days of work done. The asset is used as a tool to generate sales. If the sales are not paid at the time of delivery, a receivable is incurred as a result of the transaction. The cash flow cycle measures the time between outlay of cash and cash receipts. The shorter the cycle, the less time capital is tied up in the business process, and thus the better for the businesses’ bottom line.
If you have a negative cash as a result of the number of day between when cash is received and when cash is paid, then retirement is a far-off dream as it will be hard to draw money from the business.
The cash flow cycle is computed as:
The number of days it takes to earn income from the asset + The number of days it takes to get cash from sales + The number of days it takes to pay related expenses
For more details about the cash flow cycle, watch this video.
Financial freedom cycle
The financial freedom cycle starts with excess cash from the business. This means that after all expenses and loan payments in the business is made, there is still cash to re-invest in the business and pay dividends.
The dividends from the business are invested into other ventures outside the business. This diversifies investments and provides another source of income for the owner in case the business fails. Besides, outside investments part of the owner compensation for working in the business could include a retirement plan.
As time passes, the business might need a cash infusion for some big project. The business owner can then pull from external investments back into the business. This in turn creates more excessive cash.
At this point the business will be operating in the business as an investor rather than an operator. For this to happen, an asset that must be created is systems of doing things that include no involvement from the owner.
Over time you will see how efforts today can accumulate income in the future as new efforts are staggered with the old. The more investments you make today, the more benefits you can reap in the future. Financial freedom for business owners is about working smart: It is not hard you work, but how smart you work.
For more details take a look at Retire from my business: Module 1 and 2