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Financial Thinking
This is a mind map about "Financial Thinking". "Financial Thinking: Make Your Decisions More Reasonable" is a very practical book that can help readers establish financial thinking and improve the rationality and effectiveness of decision-making. Whether you are an individual or a business, you can benefit from it.
Edited at 2024-03-05 00:33:15
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Financial Thinking
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- Outline
"Financial Thinking: Make Your Decisions More Reasonable"
Step One: Analyze Costs
opportunity cost
The profit lost by giving up an opportunity is the opportunity cost
The reform of working methods can also be analyzed using the opportunity cost theory: overtime subsidies, improving work efficiency through tools and management, and reducing overtime costs.
Seize opportunity costs and create sales results for the future
What is the opportunity cost of a coffee shop without sockets?
In the catering industry, increasing customer flow is the golden rule in business operations. However, from the perspective of opportunity cost, the loss of customers and reduced revenue due to the failure to install sockets is obviously not worth the gain. I think from now on, there will definitely be no restaurants that don’t care about sockets and ignore the needs of individual customers.
It is difficult to take measures to improve sales performance by looking only at accounting numbers
Observe and grasp customers' trends and intentions. On this basis, roughly calculate the approximate amount of opportunity cost. If the amount is large, measures should be taken to improve it. Key points: Considering the opportunity cost factor, it is recommended not to start by increasing customer flow, but to increase sales through other methods.
Sunk costs
Exclude emotional factors and make rational judgments. Money spent in the past is a sunk cost.
The thought “it’s a pity” can make you hesitant to retreat
If you find that there is nothing here that you expected when you paid, and you insist on not leaving, it will be your own loss. On the contrary, it is wise to leave midway.
Examinations and relationships also involve sunk costs
As long as you live, you will spend time and money. People will spend money on things they think are important, and they will not stop easily even if they deviate from the original plan.
Financial thinking is exactly the opposite of human psychology, which is why it is difficult to understand
To understand sunk cost, we must first understand that it is a concept that is antithetical to our natural emotions. Eliminate personal emotions and use rational thinking to understand. Otherwise, you will have trouble navigating it.
Opportunity cost and sunk cost are opposite thinking
Key points: Pay attention to opportunity costs and ignore sunk costs.
Compare costs and benefits that will occur in the future rather than costs and benefits that have already occurred
The concept of sunk costs expresses the idea that you should not dwell on the past when making decisions. Because the past has become a fact and cannot be changed. Therefore, we should ignore the expenses that have been incurred, focus on and compare the costs that will be incurred in the future and the future benefits, and finally judge whether to move forward.
Create opportunities for mid-term diagnosis
How to prevent your business from falling into the sunk cost “trap”?
When it comes to new investment projects, investors are enthusiastic and work hard, and rarely consider the circumstances under which they should decisively exit. Even if he understands the sunk costs, it is difficult to stop when he encounters losses along the way. So, what can be done to get out of this dilemma? The answer is to do a good mid-term diagnosis. Stop and look back to see if the anticipated needs have changed. Preset the timing of mid-term diagnosis in advance and integrate the concept of sunk costs into the development process. After determining the timing of mid-term diagnosis, it is necessary to formulate judgment criteria in advance. If this can be done, even if unexpected losses occur, the amount of losses will be controllable and things will not develop to an irreversible point. Ignore sunk costs, compare future benefits with future costs, and then make your judgment. If you predict that profits will continue to decrease and costs will continue to rise in the future, you can exit decisively. However, what should we do if the predicted future income is not as good as expected, but still higher than the cost, and the investment is still profitable? This is what we usually say: the profit level may be lower than expected and the investment return period may be extended. I think in this case it should be continued. But if the profit obtained by subtracting future costs from future income is negative (loss), you should exit decisively. When it comes to sunk costs, the thing to do when making decisions is to "ignore them."
Make flexible use of sunk costs
Make flexible use of idle space
If the sunk costs that have been spent are used for other profitable purposes, the sunk costs at this time are converted into new business opportunities. (morning coffee and evening bar restaurant)
If the rent is halved with other companies, the income and expenses of the original business can be greatly improved. For start-up companies, sharing the rent can reduce cost pressure and allow them to start calmly on a small scale. The key point is to check whether the things you spend money on have idle time and idle space, and whether they can be used efficiently. Sunk costs should be ignored when making decisions using financial thinking, but if sunk costs can be used flexibly to generate new business. Key point: Make full use of what you have paid for and improve its utilization.
Flexibly allocate idle staff - run errands, find co-operation with delivery staff.
Labor cost
Labor cost is the top priority in cost composition
Outsourcing & recruiting employees & part-time jobs, compare costs by converting to hourly wages. If you hire talent in the form of outsourcing, you can terminate the contract if special circumstances arise, no other expenses will be incurred thereafter, and cost calculations will be much easier.
Consider the opportunity cost of developing an independent employee
Minimize manual work and seek business models that reduce labor costs
cash cost
Time costs
Convert time to cost
Estimating money transactions that did not actually occur
Financial thinking is concerned not only with whether money is actually flowing out, but also with certain factors such as hidden income and hidden costs, and converting them into numerical amounts for measurement.
Convert time to monetary value
What matters is whether you use financial thinking to compare the differences and make a judgment.
Financial thinking does not dwell on expense items and operating deficits
Don’t just focus on specific cost details
Financial thinking looks at the big picture and is not limited to specific costs.
To understand the true meaning of deficit
For example, when the retail or catering industry opens a store in Ginza, Tokyo, they often don't care how much profit the store can generate, but aim to build it into a flagship store to increase corporate visibility, which can save advertising and promotion fees.
Key points: In financial management, some projects do not exist for the pursuit of profits, but are used for other purposes, such as to save advertising fees, promotion fees, etc.
Be sure to make detailed cost estimates
When studying investment options, it is important for us to estimate expected sales, the duration of sales results and the required costs as accurately as possible, which is very important for decision-making.
Two magic weapons for identifying and filling gaps in cost issues
One, involve people responsible for accounting, auditing or business planning. Second, conduct thorough post-verification. Key points: Perform PDCA operations to improve the accuracy of cost analysis.
Step 2: Capture the time difference
Variable costs
Minimize fixed costs that have long-term impact
Is it a cost required for strategic development or an indispensable cost - advertising fee
fixed cost
The more fixed costs, the worse the adaptability
Convert fixed costs into variable costs
While trying to reduce fixed costs, you should also consider whether fixed costs can be converted into variable costs. This can control possible future risks to a minimum. The typical approach is to borrow as you use.
service outsource
Labor cost is the most fixed cost
When cutting fixed costs, with equal effort, priority should be given to fixed costs that can be eliminated once and for all.
The initial investment is a super fixed cost
Determining whether a certain cost is a variable cost or a fixed cost depends on how long its impact lasts. If the cost is a fixed cost or initial investment, you must carefully judge whether it is worth the risk.
The initial investment can sometimes be increased for strategic development reasons.
The shorter the payback period, the better
When sales expectations are uncertain, it is less risky for the company to prioritize variable costs over fixed costs. Unless it is certain that the company's future operations will be very stable, it must be prepared for the worst so that if an accident occurs, the company can minimize losses. However, if a company chooses this model, it may not make much money.
People tend to focus on the initial investment, the “total cost” of fixed costs
If the initial investment is large, the sunk costs will increase, which is a heavy burden for the company. On the contrary, when the initial investment is small and the annual fixed costs are high, if the company can re-evaluate whether to renew the contract every year, the loss of the initial investment will be much less once it exits. In other words, the amount of loss will also be different due to different timing of initial investment and fixed costs. Financial thinking doesn’t just focus on numbers, it also takes time into account.
The earlier the return on investment, the better the peace of mind
Built on the idea that the earlier the return, the better, is the payback period, which is an indicator of investment safety that indicates when the amount spent, including the initial investment, breaks even with the income generated. . In financial management, the shorter the payback period, the better. Our criterion for selecting solutions is that the shorter the investment payback period, the better. There are two reasons: First, money can make money. The sooner your investment returns, the more money you can generate. Second, if we predict the future development of the project based on current information, the accuracy of the prediction after four years will be significantly lower than that after two years.
Keeping cash on hand is an ironclad rule
When a company is engaged in business activities, what matters is not assets but funds. Key Point: Companies need money to invest, and raising money incurs costs.
Money has different values at different times
Money now is worth different things than money one year from now - net present value, discounted.
Step 3: Make comparisons
1. Determine the judgment criteria
Determine the original purpose
Make standards clearer in numerical form
During the product research and development stage, Alice Group has instilled its own judgment standards into the R&D personnel, which are also the company's strengths - the functional charm of the product and the cost-effectiveness concept of "value for money". In order to ensure "value for money", we first need to set a price that makes consumers excited, and conduct research and development based on this premise. Therefore, "many functions" will not appear in the Alice Group's judgment criteria. Determining judgment standards based on company strategy avoids the problem of product convergence within the same industry.
When multiple judgment criteria appear, it is necessary to determine the order of priority - in business practice, we need to collect multiple alternative solutions, analyze why they were selected as candidate solutions, and what their advantages are, and then use this view as the judgment criterion Supplementary options for analysis and judgment.
Important judgment criteria must be shared by all employees - the company's priority criteria must not be determined in silence without any business strategy.
2. Collect all alternatives and finally compare them
Broadly solicit ideas and then narrow them down - When learning business skills such as coaching and logical thinking, we encounter the concept of "diffusion and convergence." The same goes for financial management, first think broadly and then filter accurately.
Pay attention to the differences and make comparisons - key points: Collect and propose all possible solutions and express their characteristics numerically.
3. When discussing multiple options, use the “threshold rate of return” as a criterion
Pay attention to profitability (break-even point) The standard must not be lower than the weighted average cost of capital (WACC) - rate of return "Internal rate of return > threshold rate of return" is a necessary condition
4. Flexible use of net present value and internal rate of return - payback period, net present value, internal rate of return
5. Predict unexpected situations in advance and prepare for the worst - after determining the plan, predict the number of years the investment will show effect, the amount of initial investment and sales.
Step 4: Decompose
Compare after decomposition - the larger the number, the more it needs to be decomposed and analyzed by unit numbers. ——The current total population of Japan is approximately 126 million (data as of June 2019). After dividing by the number of convenience stores, it can be concluded that the population corresponding to each store is 2,270. In other words, as long as the population of a certain business district reaches about 2,000, convenience stores can be opened.
After breaking it down, you will know how to act
Prioritize controllable items - determine which factors you cannot change and which factors you can change through your own efforts, see how these factors change, and then make a judgment.
Why can you qualify for the lottery by "purchasing goods over 700 yen"? How does this decomposition approach apply in business? Why use sweepstakes as a marketing strategy? Is it to increase the number of customers or to increase the customer's single consumption price? How much? These all depend on business strategy. As mentioned in step 4, after decomposing the numbers, the final judgment criteria need to be determined, and the fundamental basis for determining the judgment criteria is the business strategy.
After decomposition, "fixed-point observation" can be carried out in time - through decomposition, data performance can be viewed regularly.
After decomposition, it becomes one's own "partiality" - decomposition goals: who, what to do, and to what extent - the important thing is to hand over the controllable parts to people who can control them, and let them do a good job in dividing them. internal affairs. There should be no ambiguity about work, we should translate work goals into numerical form and consider how to execute them. Note that you need to think quantitatively at this time, not qualitatively. The focus is on the results, not the process.