Cash: Austin’s Cycle Shop

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A few years ago, Austin opened his own bicycle sales and service shop— called Austin’s Cycle Shop. He determined that he needed $50,000 to get up and running, so he used money from his own savings and borrowed money from a bank and a private investor, his brother-in-law. Start-up costs – his store lease, professional fees, licenses, furnishings for the store, inventory (bikes and parts), and equipment – were $40,000. He put the remaining $10,000 in the bank as a safety net for the early months when sales and revenue might be shaky. So his initial cash position was $10,000.

 

But during the first year, Austin collected $70,000 from selling and servicing bicycles. He also had expenses of $55,000 (he took a very small salary that first year). So how much cash did he generate from his operations? What was his cash flow? Right, $15,000. He never touched his initial cash reserves, so at the end of year 1, he had a total cash position of $25,000 ($10,000 cash position + $15,000 cash flow).

 

Austin had choices in what to do with the $25,000 cash he had at the end of his first year. He could put the entire $25,000 in the bank for maximum liquidity. Or he could use part or all of it in investing activities; such as remodeling the building, making a down payment on a truck, or buying stocks or mutual funds for a greater return than his savings account offered. Or he could use it in financing activities; such as paying back part of his bank loan or repaying his investor. But Austin decided that for maximum safety and liquidity, he would keep all of his $25,000 cash balance at the end of his first year in the bank. He had done well in the first year, but you never know when a competitor might open up across the street or a piece of equipment might break.

 

In his second year, he received $100,000 in cash from sales and spent $80,000 in operating his business, so he generated $20,000 in cash flow. With higher cash flow in his second year of business, Austin decided to start using his cash. He paid back a portion of his bank loan, he bought a used truck so that he could offer to pick up and deliver customers’ bikes, and he bought out his brother-in-law’s investment. His brother-in-law was supposed to be a silent investor, but it didn’t quite turn out that way and Austin was getting tired of the stream of advice he was getting during holiday meals.

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Austin could have used even more than $15,000 cash in nonoperational activities. He still had a cash position of $30,000. He could have used, say, $10,000 more ($25,000 total) to buy more equipment or pay off more of his loan. He would have ended the year with only $20,000 ($45,000 total cash available minus $25,000 used for investing and financing activities)—which is less cash than the $25,000 he had at the end of year 1.

 

Would ending the year with less cash than he started have made Austin a bad manager? Not at all. He would have simply made a business decision that it was more important to his future operations to acquire assets, pay back the loan, and repay his investor. And because he generated more cash from operations – greater cash flow – in his second year ($20,000) than in his first ($15,000), Austin should be considered a good business manager, especially in a start-up enterprise.