Friday, April 29, 2005

Dollar Bills Y'all

Notes from the financial front lines:

I'm not a financial genius; not even a whiz, so this may be less cohesive than usual. But ever since I learned that I needed to understand what sort of processes were involved in the making of profit, I have mercilessly pummelled my brain cells in an attempt to grasp some of the particulars.

I have lately tried to compare our situation to that of a small business, in light of what I have been able to absorb.I wouldn't say we're "flush with cash", but we have a modicum analogous to what a small business might have.

The 'Bonnie & Malcolm Company' has, of course, overhead, which amounts to necessities - a space in which to conduct business (a home), utilities, equipment (car, clothing, food, etc.) We have two employees (ourselves), so we have a payroll.

A small business has several options - it can return a dividend to its loyal shareholders, it can hire more workers, it can buy new equipment, it can invest its cash, it can buy back shares.

Returning a dividend makes shareholders happy, but investor goodwill isn't all that important unless investors start bailing, which seldom happens in a bull market, because many investors equate paper appreciation with actual income. It's only when investors feel as if they're making less than a good return that they start to get antsy.

Curiously enough, that seems to be the case these last few years, as investors burned by the tech bubble are less likely to put their money into high-flying, low-paying stocks. Also, many investors, particularly large institutional funds, are attempting to make companies more responsive to shareholders (e.g., Disney.)

Returning money to investors, of course, is the least palatable option - after all, that money is not being put to use for the good of the corporation; it's basically going to waste.

Say, for example, that the B&M Co. takes money from relatives and promises to give them a return on equity. Since the B&M Co. would, in this case, be a hedge fund, we would have to make wise investments in order to satisfy the relatives. Every dollar that we returned to them is a dollar not being put to use for ourselves.

In today's competitive business environment, hiring more employees is not a very good option either, because more workers often means added expenditure and less productivity, leading to less profitability. And profit, after all, is the main, perhaps the only reason for the existence of a business.

If the B&M Co. were to hire nieces and nephews, said nieces and nephews would expect to be paid a decent wage and would probably also want health benefits. (Besides, they might turn out to be layabouts and ne'er-do-wells.) Our company would be better off hiring 'contract workers' (aka 'temps') who would be paid by the employment agency and would not expect the B&M Co. to give them benefits or vacation days. In extreme cases we might even outsource.

Buying new equipment is only necessary if old equipment becomes too expensive to maintain, or if better, more productive equipment is available.

(The B&M Company is as thrifty as any small business in this respect.)

Investing excess cash is an attractive option, because properly invested money will earn either a return on equity or actual income, without having to produce tangible goods or services.

(Needless to say, this is a very attractive option for the B&M Company.)

The last option, buying back shares from shareholders, is the most desirable of all, from the company's viewpoint, because a continuing source of cash drain is closed off and shares are concentrated in the hands of fewer people. An added benefit is that there is more cash with which  to invest. In extreme cases, the company might well go private, doing away with outside shareholders altogether. (This option works best if shares can be repurchased at a reasonable price.)

The B&M Co., when graced with an infusion of cash, hastened to buy back its shares from its 'investors' (i.e., credit card companies.) Happy B&M Co.!

I hope you don't mind my sharing this little exercise in financial self-explication with you. As I age, I find that it helps to write things down so that my thoughts might more easily wrap around a particular subject. Now I have to sit back and study it awhile so I can fathom 'what it all means'.


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