Cash base accounting 　― Where the money you earned is ―

This time, Inamori* spoke about the above motto in his book : Practical Accounting -Business Administration and Accounting -. What Inamori said is quoted with “”.

Mr. Inamori* highlighted the below four points for us to understand how important it is to run a business based on cash, in the chapter of ” Business administration based on cash”.

Where is the money we earned ?
Lessons learned from “Sales pitch performance.”
Take sumo wrestling in the middle of the ring (sufficient reserves)
Made profit but little cash left (always reserve the minimum cash)

I will explain them one by one.

１．Where is the money we earned?

“ It was then that I finally realized that the balance sheet represented various account items such as fixed assets, inventories, trade notes receivable, accounts receivable, etc. Even if you make a profit through hard work, it cannot always be used for new capital investment. If your accounts receivable or inventory increases, those are items that the money which is counted as sales is transformed. If you pay off the debt or tax, the money disappears. At that time, I fully understood where the money was and in what form the money was transformed. “

→ Even if you make a lot of sales, unless you collect accounts receivable, your cash may be repaid loans or paid taxes, and therefore, almost no cash left. We should understand what sales or profit is. I think this is a very important point of view when investing in real estate. Even if you think you have this much rental income, if something like the COVID pandemic happens, you won’t get any rental income, and only your taxes and debt repayments will increase. It may be too late to realize that you are supposed to have some funds to pay fixed costs.

２．Lessons learned from “Sales pitch performance”

Inamori referred to the example of “Sales pitch performance” when a guy sells bananas.
” Since the sales were 3000 yen and the cost of purchasing bananas was 1000 yen, the profit should be 2000 yen. But when I counted how much money was left on my hand , I didn’t have that much money. I paid 300 yen for the apple box, 2000 yen for the cloth, 200 yen for the stick, and in total 2500 yen for the tools (for sale), so I have only 500 yen left. Suppose the tax officer comes and says that I have earned 2,000 yen so I should pay 1,000 yen, half of that amount, as tax. When I asked him why I had to pay 1,000 yen in taxes on the 500 yen, the tax officer said, `The apple box, cloth, and sticks are assets, not expenses. 1,500 yen assets and 500 yen money will be in total 2,000 yen, and tax will be imposed on it.’ Unless you save money to pay such tax, you would be running out of cash to operate business. . . . This lesson tells us, no matter what kind of profit comes out, in the end, the only thing you can use is your own money, cash. In other words, there is nothing other than money that can be used as one’s own that enables new investment to develop a company. ”

→ When you think about spending money as budgeted, if this investment will not generate income, the expenditure must be treated as an “expense” rather than an “asset”. Considering this, I think it’s important to be cautious even when buying a single consumable item. And I think management is about how much free cash you can have (which can be used for capital investments). Considering this, I think that the 10% or more profit that Mr. Inamori has been encouraging us to make is the minimum necessary target for the healthy business administration.

３．Take sumo wrestling in the middle of the ring (sufficient reserves)

” You won’t be able to work as a manager when you’re always concerned about money. Thus, first you must make sure you never run out of cash. Some people believe that they are doing their best in terms of the management, while they are always struggling to arrange finance to make ends meet. I don’t believe that they are properly doing their management jobs. They never create profit, just keep avoiding losses. In Sumo wrestling, those managers look like a wrestler who is hustling at the edge of the ring and trying to throw the opponent away. I feel that they should have brought such guts when they were in the middle of the ring. It is too late to bring their best efforts when they are really in a risky situation. Never do such a quite risky play if you are the management. I can say the same for the business administration. We should be able to concentrate on our management with a sufficient financial condition .Such a strong determination allowed Kyocera to be no debt company from its early stage. ”

→ I think how important it is to have sufficient cash reserves. At the same time, when you have enough cash, it is difficult to feel the tension of being cornered at the edge of the ring. Even if you have enough savings, I think it is important to face your work and life very seriously as if you are in a quite risky position.

４．Made profit but little cash left (always reserve the minimum cash)

” I often use the phrase ‘ Made profit but little cash left ‘ to emphasize the importance of operating on a cash basis. We often see companies that manage to make a profit every year, but their actual cash flow is insufficient, and they are always short of funds. This is probably the result of operating only on a ‘profit basis’ in financial statements rather than on a ‘cash basis.’ However, profits from business activities are essentially a major source of cash. Therefore, if accounting is nothing more than calculating profit on the financial statement and completely separates profit from cash, the accounting itself may end up being a useless practice as it never helps the actual business administration. ”

→ If you run out of cash, you must thoroughly identify where this discrepancy comes from. I thought it would be quite important to solve the problems one by one, such as time lag in sales collection, a large amount of debt, many fixed assets or inventories.

In summary, the money (profit) the company made should be recorded and saved in the company as a form of cash. If you don’t have sufficient cash, you’ll need to analyze where your money is turning into and constantly calculate and figure out if you can cover expenses which have to be paid by cash. Furthermore, it is important to secure sufficient profit, considering those cash payments.

* Mr. Kazuo Inamori, the founder of Kyocera, KDDI (one of the top tele communication companies in Japan) and the top of revitalization project of JAL. As a well-known Japanese entrepreneur, he has been sharing his experiences and management know-how with managements of small to middle companies in Japan.