Paul Meeks, Independent Solutions Wealth Management Portfolio Manager
Paul Meeks is a long-time portfolio manager and professor of finance and accounting at military college, The Citadel.
The following is a transcript from an interview between Square and Paul Meeks. It has been edited for length and clarity.
Let's talk about building credit. How should a business owner approach getting started?
Paul: First of all, I would say everybody needs to have credit. You would think that if you were a person or a business and you had a powerhouse balance sheet, lots of assets, little liabilities [you would not be worried about credit]. Of course the difference between assets and liabilities for a person or a company is your wealth. Even Apple, which generates about $1 billion of free cash flow or surplus cash per week, all year round, year in and year out, they borrow money. So establishing credit is absolutely key. I would say this applies both to you and me and also to businesses. You should be aware of your balance sheet. If you are a publicly traded company here or abroad and your shares trade on any major exchange, every quarter of the year in the United States, the securities and exchange commission requires that you show to shareholders your balance sheet, your income statement, your cash flow, and some other disclosures.
So people think "Well, that's kind of a corporate gig. It doesn't really apply to me." I disagree. You can and probably should create your own financial statements. Do you have to update them and share them with the world every quarter a company that trades publicly? Of course not. But you think about the balance sheet, you list your assets, which are the things you own, and then you list your liabilities, the stuff that you owe, and the former minus the latter is your wealth. A company would call that shareholders equity. You could call it wealth or net worth. One of the ways you can do this effectively as a person is have a proper budget. Make sure the stuff you own is much more than the stuff you owe.
What tools can business owners leverage to manage cash flow?
Paul: There are all kinds of templates out there to create a personalized template for your balance sheet, maybe your cash flow statement, and even your income statement. So the balance sheet, right? Assets minus liabilities is stockholders equity or wealth. An income statement is all about your sources of cash and your expenses. If you have more revenue than expenses, you have profits. Of course, that's the end game for you and I, and for any company.
If a bank is going to analyze you or I to give us a loan, they [would] use a formula. What is this person's revenue after tax? Let's make sure that their car loan, their apartment rent, their mortgage loan are no more than 40% of that. If you can go through over time, following the 40% rule, you'll likely always be able to get a loan, and you'll be in pretty good shape. Then the last is the cash flow. It's the easiest of the three financial statements. It's cash flow in, cash flow out. I think it would be a very good thing to keep your expenses capped at 40% of your income, you will always be in good financial shape with any potential lender, if you follow that rule.
What are some ways a lender or investor might valuate a business?
Paul: If I look at a business, whether it is a startup or a more mature business, it's all about cash flow. When you read the papers and follow financial media, there's always talk about sales, growth rates, and earnings. I know Wall Street likes to focus on that stuff, but, at the end of the day cash is king. I know it sounds trite to say that your business generates cash or it does not. If you're a startup company it's cool that you don't generate cash because I'd want you to spend a lot of money on R&D (research and development), particularly if you're a tech-oriented company. Nobody expects you to have more mature company cash flow for some time. But what I need to see is a pathway to cash flow and so manage your business to maximize cash flow and tell your investors, either existing or prospective investors "Yes, we're a startup. We're investing heavily in R&D. I can show you that my cash flow burn is a $100 million. Next time I come back, it's gonna be $50 million, and next time it's gonna be $20 million, then the next time we're going to break even." So all businesses come up with a timeline. If you're not cash flow positive now, you have less and less cash burn. Then you have a breakeven point and more and more cash built. That's, at the end of the day, what it's all about.
Are there factors that would make a business appear riskier to a lender?
Paul: One thing I would say that would differentiate a business being risky or not risky is that risky businesses have high fixed costs. Some businesses, like hotels and the restaurants, have high fixed costs. If I was to start a business today, it [would] have high variable expenses and low fixed expenses. High fixed cost businesses, when things happen (whether it be Russia invading the Ukraine, COVID variants...macroeconomic variables that we cannot avoid) if you have a variable cost business, you can weather the storm. I think cash flow monitoring and variable, not fixed costs, are two key things that I would look for for any business.