From an economic perspective, entrepreneurship or business ownerships success if evaluated from its financial returns
For an entrepreneur, financial returns from a business are measured from the following metrics:
1) Dividends
2) Valuation growth
3) Compensation yield
If a business does reasonably well, then not only does the entrepreneur make an income by being a part of the top management but also by investing at a very low valuation in a business that sees valuation growth over time.
Many businesses owners evaluate the success of their business through the quantity of profits. However, the amount of capital that has been invested in order to generate these profits must be considered in order to evaluate the performance of the business.
As an example, if the net financial returns from the business are around 3% per year then the entrepreneur is better of putting his capital in a fixed deposit if the fixed deposit offers him a higher return than 3% per year.
Let us assume a very simplified version of a business setup by an entrepreneur
Investor invests 100 into the business
In year 1, the financials are the following
| PnL: | |
| Revenues | 200 |
| Costs | 85 |
| Profit after Tax | 15 |
| Balance Sheet: | ||||
| Assets | Liabilities | |||
| Fixed Assets | 70 | Current liabilities | 50 | |
| Working Capital | 80 | Shareholders Equity | ||
| Paid up capital including premium | 100 | |||
| Retained Earnings | 15 | |||
| subtract: Dividend | 15 | |||
| Subtotal of shareholders equity | 100 | |||
| Total | 150 | Total | 150 |
Now assume that the entrepreneur sells his business immediately as soon as a year gets over and that he gets a multiple of 10 times Profit after tax for selling the business. The entrepreneurs cash flows look like the following:
| Time | Beginning | end of year 1 |
| Investment by entrepreneur | -100 | |
| Dividend received | 15 | |
| Cash receipt on sale of business | 150 | |
| Total | -100 | 165 |
The return made by the entrepreneur in the above case is about 65%.
If the business grows over several years, the above math leads to a huge financial return for the entrepreneur.
Entrepreneurs should always keep the above in mind as they run a business.
Disclaimer: Vitspan does not provide any investment related, tax related or financial advice. The information presented is done so without considering the investment objectives, risk profile, or economic circumstances of any reader or investor. The information presented may not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the potential loss of principal. Please consult your financial advisor prior to making investment related decisions.