Since this series is primarily concerned with the question “What is money?” it’s necessary that we at least have a general historical perspective of humanity’s relationship with money. What money have we used in the past, and how has it changed as humanity came into contact with successively superior forms of money?

We weren’t always using rands and dollars. Money, just like technology, language and life itself, evolves. In fact, the most recent form of money, fiat, will only be 50 years old in 2021. More on this topic in a moment.

The traits of sound money 

Examples of primitive forms of money are numerous: shells, salt, glass beads, cattle, rare stones etc. These early forms of money were by no means perfect and lacked several of the characteristics of sound money as outlined below:

The hardness of money is its resistance to unpredictable supply increases and debasements of value. Fungibility requires that units are interchangeable and indistinguishable from one another. Portability is the ease with which monetary units can be transported and transmitted across distances. Durability entails the resistance of monetary units to rot, corrosion or deterioration of value. Divisibility is the ease at which monetary units can be subdivided or grouped. Security is the resistance to counterfeiting or forgery.

Of the traits listed above, hardness is the most essential. Historically, only truly scarce and hard-to-acquire items could function as a reliable form of money – scarcity was the critical element. This scarcity could be unlocked by expending tremendous amounts of human time and energy. In other words, it was a challenging process to come into the possession of this scarce item. The harder it is to create this money by expending time and energy, the harder the actual money is. That is why humanity eventually settled globally on gold as the superior form of money: it had an annual inflation rate that was closest to zero and satisfied the majority of the critical traits of money. Eventually, even silver was demonetised in most parts of the world as the supply could more easily be inflated by expending more energy. With gold, this was the hardest to do.

Money hacking and the birth of inflation

Terrible human tragedies have occurred in the past where different groups of people came into contact with others using relatively “softer” forms of money. Inevitably, one group’s money could easily be “hacked” by the technologically superior group.

For example, when Portuguese and other European traders came into contact with West Africans exchanging tiny glass beads on the Gold Coast, known as aggry beads, they realised that the West African people had no interest in their foreign money. The Portuguese, however, had access to Venetian glass-making technology which was lightyears ahead of the West Africans at the time. These traders went back to Europe, accumulated many cheap glass beads, and flooded the Gold Coast’s “scarce” money with cheap money. The aggry bead had been hacked. The Portuguese proceeded to trade everything of actual value – food, clothing, cattle, land and so on – for worthless glass beads. It was time and value theft on a monumental scale. The scarcity of West African money was corrupted, and a world of value was confiscated.

There are various other examples of this type of “money hack” occurring throughout history. Another interesting example of this happened on the island of Yap in Micronesia, where the Yapese’s precious Rai Stones could be quickly and cheaply created by an Irish-American captain and his crew who got shipwrecked on the shores of Yap.

–  Rai Stones on the Island of Yap

Today, this same surreptitious form of theft is happening on a global scale that dwarfs these historical scenarios. The mechanism that makes this possible is commonly referred to as inflation, whereby more money is created and injected into the economy, supposedly to stimulate spending and economic growth.

Inflation is taxation without representation – everyone who holds cash pays this tax – but since it’s not a direct payment, nobody notices or realises that their hard-earned value is slowly melting away. Historically, the rate of devaluation has been too gradual for us to feel the diminishing value and purchasing power of our money (much like the proverbial frogs in boiling water). Still, there is reason to believe that this is about to become increasingly evident in the years to come.

What happened in 1971?

The reason that we’ve been able to uninhibitedly create money out of nothing for the past 50 years (as of 2021) is because of the following oft-forgotten moment in history:

In 1971, President Richard Nixon effectively abandoned the global gold standard. You can find the whole speech online, but here’s the crucial snippet for context:

“In recent weeks, the speculators have been waging an all-out war on the American dollar. The strength of a nation’s currency is based on the strength of that nation’s economy — and the American economy is by far the strongest in the world. Accordingly, I have directed the Secretary of the Treasury to take the action necessary to defend the dollar against the speculators. I have directed Secretary Connally to suspend temporarily the convertibility of the dollar into gold or other reserve assets, except in amounts and conditions determined to be in the interest of monetary stability and in the best interests of the United States.”

– President Richard Nixon’s address to the nation, 15 August 1971.

Notice that word “temporarily”? Well, as it turned out, it was permanently. Thanks to the Bretton Woods Agreement, which was introduced after World War II, the dollar was backed by gold, and all other currencies were pegged to the dollar. Since Nixon suspended the convertibility of the dollar to gold, the tie to gold for the whole world was effectively broken. And so we entered into the age of fiat currency – the softest money we’ve ever had, controlled by governments and central banks (and by extension the wills and whims of those at the helm of these institutions).

Humanity’s money has changed and morphed throughout history based on relative scarcity and the technological capabilities of the time. Since our tie to gold was broken in 1971, money is no longer scarce. It is being created with no particular expenditure of time or energy at the discretion of global governments and central banks. It’s all heading in one direction, sharing the inevitable fate of all fiat currencies throughout history: hyperinflation and ultimately, worthlessness.

This form of money has profound implications on the state of society itself: rampant consumerism and short term preferences are a natural result of a form of money that incentivises immediate gratification (i.e. our collective time preference as society becomes higher and higher – we increasingly tend to neglect the longer-term consequences of our decisions in favour of the short-term).

Where do we go from here?

The global fiat monetary experiment celebrates its 50th birthday in August 2021. Perhaps we should rather consider it the 50th anniversary of the gold standard being hacked. This seems more apt (and less celebratory).

Here is the main problem with having a select group of people able to control something as powerful as money itself: the temptation to breach the trust of the masses and abuse this power for personal gain is too great to resist. As the old adage goes: “Power tends to corrupt and absolute power corrupts absolutely”.

In the next instalment of The Melting Ice Cube Series, we take a closer look at inflation from a numerical perspective and how seemingly small figures, compounded over time, melt the ice cube at an ever-increasing rate.

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The cash flow statement is the final piece of the puzzle when it comes to the monthly management reports that we prepare here at Creative CFO. This is without a doubt one of the most important and often overlooked financial reports within the monthly report pack.

The cash flow statement in context

The profit and loss statement, discussed in an earlier blog, provides information on the revenue and expenses over a certain period of time. This is used alongside the balance sheet, which gives a snapshot of the financial health of a business. Out of the information from both of these reports, the cash flow statement is born.

Cash is the heartbeat of a business. A business requires cash to be able to pay its suppliers, vendors and employees, but it also needs cash to be able to invest back into itself in order to grow. The cash flow statement can show how effectively a business is managing its cash inflows and outflows over a specified period of time. This is particularly important to investors seeking to determine the short-term viability of your company, particularly its ability to generate cash and pay bills.

In accounting terminology we often refer to “accrual versus cash accounting”, and this really sums up the importance of understanding the cash flow statement and how it can be utilized to grow your business. “Accrual versus cash” refers to the method in which a report is drawn up. Accrual accounting reports on revenue when it is earned and expenses when they are incurred. Generally, your profit and loss statement is drawn up on the accrual basis. This means that you could earn revenue by invoicing your customers and this will reflect on your profit and loss statement, but until cash changes hands and you receive the money in your bank account, it will not increase your cash immediately. In essence, profits do not always equal cash.

When we look at our monthly reports, it is common to go straight to the balance sheet to see what the bank balance was at month end. However, it does not necessarily tell you how it came in or went out during the month.

Breakdown of the cash flow statement

Let’s take a closer look at the components that make up a typical cash flow statement by using the example below.

Based on the indirect cash flow method, we will start with the operating profit/loss which is pulled directly from the profit and loss statement. This is then adjusted to take into consideration non-cash movements, as well as cash movements, to reconcile at the end of the report with the actual cash balance that you have in the bank at a specific month end.

Depreciation and amortisation are always adjusted for, i.e. added back, as no physical cash leaves the business for these transactions. The only time that cash is affected is when we actually buy the asset. Depreciation and amortisation simply show how the expense is allocated over its useful life.

We can then split the rest of the report into three main sections:

1. Cash generated from operations

This is such an important section of the cash flow report as it showcases how the core of your business is generating and utilizing cash. If we take a look at the movements that are represented in the above image, we can establish how these movements affect the amount of money we have in the bank.

For example, if we take a look at the (increase)/decrease in trade debtors – this would be your customers whom you have invoiced, and if this figure increases then we adjust the net income by deducting the increase, and if it decreases, we adjust with a positive figure.

At the end of the cash flow from operations, you ideally want to see a positive number here, otherwise the company is not raising its cash from its core business activities which could raise a couple of red flags. One of the most common causes of this could be that your cash is tied up – you are perhaps giving your customers long payment terms or your receivables are very overdue – which means you have to continue paying your expenses and suppliers before you have actually received the cash from your customers.

2. Net cash from investment activities

This is cash spent or received from investments, which is outside the core of the business. If you perhaps purchase a new asset or purchase shares in another company this will be reflected here.

3. Net cash from financing activities

This represents the raising, borrowing or repaying of loans and issuing of new shares or dividends paid, to name a few. If you receive a loan from the bank, the cash comes in, so this will be represented as a positive amount on the cash flow statement. This is then easily identifiable to the person reading the report that money has come in. When the company repays the principal portion of its loans, this will be presented as a negative amount, which means that cash was used which reduces the bank balance.

Managing cash flow is vital for business success, it really can be summarized as doing anything and everything possible to ensure money is coming into the business as quickly as possible and exiting as slowly as possible. In order to summarise the cash flow statement visually we use the waterfall representation as part of the monthly management reports, an example of which is below.

Tips for getting the most out of your cash flow statement

To end off, we will leave you with a few of our top tips to keep in mind for when you are next reviewing your cash flow statement and forecasting for the upcoming months:

  • Profit does not equal cash, so don’t count income until it’s in the bank.
  • Plan for the unexpected. Before you purchase that awesome new coffee machine, make sure you have cash in the bank to cover at least two months’ operating expenses.
  • Be prepared for growth. When a business grows, it more often than not comes with additional costs which can include marketing, buying additional inventory or on-boarding additional resources.
  • Line up your invoicing and collections. Too many small businesses land up with customers with long outstanding debts. Make sure to stay on top of your debtors or implement a debit order system from the start.
  • Always have an up-to-date cash flow forecast. It is vital to know what your cash commitments are for the upcoming year.

The cash flow statement is one of the most integral components of the monthly management report pack that Creative CFO provides. Now that you know what it means to have an up-to-date cash flow statement, get in touch with us to discuss your business’s financial reporting needs.

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