What are banks for?

What do banks do?

I get a few emails with humour coming around at work, which I am sure most of you do too. Most of them, I read and delete. I thought I would publish this one because, although it first came out in 1957, it seems entirely up to date.

Imagine a banker being interviewed about what banks do:

“Q: What are banks for?
A: To make money.

Q: For the customers?
A: For the banks.

Q: Why doesn’t bank advertising mention this?
A: It would not be in good taste. But it is mentioned by implication
In references to reserves of £249,000,000,000 or thereabouts. That is
The money they have made.

Q: Out of the customers?
A: I suppose so.

Q: They also mention Assets of £500,000,000,000 or thereabouts. Have
They made that too?
A: Not exactly. That is the money they use to make money.

Q: I see. And they keep it in a safe somewhere?
A: Not at all. They lend it to customers.

Q: Then they haven’t got it?
A: No.

Q: Then how is it Assets?
A: They maintain that it would be if they got it back.

Q: But they must have some money in a safe somewhere?
A: Yes, usually £500,000,000,000 or thereabouts. This is called
Liabilities.

Q: But if they’ve got it, how can they be liable for it?
A: Because it isn’t theirs..

Q: Then why do they have it?
A: It has been lent to them by customers.

Q: You mean customers lend banks money?
A: In effect. They put money into their accounts, so it is really lent
To the banks.

Q: And what do the banks do with it?
A: Lend it to other customers.

Q: But you said that money they lent to other people was Assets?
A: Yes.

Q: Then Assets and Liabilities must be the same thing?
A: You can’t really say that.

Q: But you’ve just said it! If I put £100 into my account the bank is
Liable to have to pay it back, so it’s Liabilities. But they go and
Lend it to someone else, and he is liable to have to pay it back, so
it’s Assets. It’s the same £100 isn’t it?
A: Yes, but…..

Q: Then it cancels out. It means, doesn’t it, that banks haven’t
Really any money at all?
A: Theoretically……

Q: Never mind theoretically! And if they haven’t any money, where do
They get their Reserves of £249,000,000,000 or thereabouts??
A: I told you. That is the money they have made.

Q: How?
A: Well, when they lend your £100 to someone they charge him interest..

Q: How much?
A: It depends on the Bank Rate. Say five and a-half percent. That’s
Their profit.

Q: Why isn’t it my profit? Isn’t it my money?
A: It’s the theory of banking practice that………

Q: When I lend them my £100 why don’t I charge them interest?
A: You do.

Q: You don’t say. How much?
A: It depends on the Bank Rate. Say a half percent.

Q: Greedy of me?
A: But that’s only if you’re not going to draw the money out again.

Q: But of course I’m going to draw the money out again! If I hadn’t
Wanted to draw it out again I could have buried it in the garden!
A: They wouldn’t like you to draw it out again.

Q: Why not? If I keep it there you say it’s a Liability. Wouldn’t they
Be glad if I reduced their Liabilities by removing it?
A: No – because if you remove it they can’t lend it to anyone else.

Q: But if I wanted to remove it they’d have to let me?
A: Certainly.

Q: But suppose they’ve already lent it to another customer?
A: Then they’ll let you have some other customer’s money.

Q: But suppose he wants his too….and they’ve already let me have it?
A: You’re being purposely obtuse.

Q: I think I’m being acute. What if everyone wanted their money all at
Once?
A: It’s the theory of banking practice that they never would.

Q: So what banks bank on is not having to meet their commitments?
A: YOU GOT IT!”

Tags: assets, banks, Finance, Five, liabilities, practice, reserves
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Is change as a good as a rest?

It's not restful at the time

Moving house this week reminded me that it is not for the faint hearted. It really is one of the most stressful events in life. Not only is it expensive, it is all-consuming. My wife and I were about to instruct our estate agents to pull the house off the market four months after eighteen months of no success in selling it. We had the usual trail of people viewing it, albeit a handful of people.

For each viewing, we would tidy up and ‘dress’ the house to attempt to make it as appealing as possible to the viewers. Sometimes, the viewers didn’t turn up. Sometimes, they were just nosey. But the day we rang the agents to take it off the market, they said they had a couple who wanted to view the house and they were ‘hot’ prospects.

We duly tidied up the evening before their appointment with a coolness towards the prospective buyers. They arrived the next morning and they seemed to like it. They left to see the rest of the houses on their itinerary.

In short, they loved our house and offered a good price for it. We accepted. Four months later, after the ups and downs of dealing with ‘official vlauers’ who valued it lower than the offer price, arranging mortgages and coordinating the day of the move, we exchanged contracts and completed the deal on our house and the house we now live in.

After eight years of living in an English country cottage, my family and I moved out of the countryside and into our local town. We spent two weeks packing boxes, throwing out unwanted items and wondering how we had accumulated so much stuff.

Last Monday, the removal men arrived and cleared out our house while we cleaned the house to make it presentable. We said ‘au revoir’ to our neighbours and drove the five miles to our new place, only to see that our new house still occupied by its previous owner who was refusing to leave the now empty house until she had the keys to her new house. “Would you leave your home in the knowledge that you had no home to go to?” was her reasoning. I politely reminded her that we had just done that and that she was now in my home. She left fifteen minutes later.

Soon after, the removal men emptied their lorry of our goods and into the new house. By 5-30pm, they had finished the heavy lifting and left with a tip from us for doing a good job. Emptying boxes and finding new places to put items continues and will do so for a while. At 10-30pm, we collapsed into bed, shattered. The emotional and physical pressure had been immense, lightened during the day by family helping, friends visiting to welcome us to our new home and offers of help from our pals.

We have started new routines in the house and we are feeling the benefits of the new environment including being able to walk into town, and our children can walk to school or take the bus. Financially, we are now better off for having downsized our mortgage and moved into a house which is cheaper to run. We know it was a good thing to do, despite the feeling that perhaps this move could be seen by us as a negative step.

Our perceptions before moving into town were that it would be noisy compared to our village house. We were wrong. We thought the house would feel smaller. We were wrong, it feels no bigger or smaller than our old home, but the space is better used and designed.

The question in the title of this entry is a cliché, but I asked it anyway. The fact is that change is hard work, stressful and tiring. Our house move is a sign of the times in that we had to move to make sure that our family finances went from sliding into the red to being in the black. We have gained so much and we have only lost some misconceived perception that the move was a result of failure in a business venture last year. The change has enabled us more choices and control over our immediate lives and what we want to do in the future.

It has been worth it despite the cost and the stress. Change is not restful at all. What happens after the change is what we focused upon. We are now leaner as a household and more nimble. The family finances are showing a surplus already which is the first time in a long while. I now need a holiday.

Our recent move feels like a mini version of the world we are in now. Climate change, downturn and adjustment. It is painful for people to change but you do come out of it with renewed vigour, purpose and ability.

Tags: business, change, design, Finance, Five, focus, media
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Thank goodness for the recession

Generation M wants to be great at doing stuff that matters

Before you get upset by my heading, I really do mean this as a personal comment. I know several people, including friends, who have been badly affected by the recession in their businesses. I too have had a couple of tough years, most of which came from starting a business at the beginning of 2008 which is still going but for which I am no longer working on.

Bad timing, perhaps, and the recession did not help. The business strategy was ambitious. We were taking a new product to markets we thought we knew well but the clients were cautious and they did not buy as much as we thought despite the benefits available to them. I have learnt a lot in the last two years of my business life and my home life.

One of the main consequences of the business last year is that I have had to look through my personal finances to adjust my lifestyle according to my funds. And it has been a valuable exercise in highlighting how inefficient my household had been in the last ten years with the way we were spending money.

For example, we had borrowed money to extend our current house in a modest way. It improved the house, for sure, but the house has a limit to what people were prepared to pay for it and the growth in the equity has not improved enough to have made it worthwhile. We are selling our house and moving, hopefully, into a new town house which has energy bills half that of our current house. We will drop our mortgage by £100,000 by moving into the new house and it feels good.

Furthermore, it will save us having to drive our children from our current village house to school in town. The children can now walk to school and we save a lot of money on petrol.

Also, I have downsized my car to a car which does 70 miles per gallon (mpg) and 80 mpg if I drive a little more carefully. What was I doing beforehand in a car which only managed 25 mpg? Also, the tax on it is much lower than the previous car.

I admit that I am now becoming a bit obsessive about what I use day to day and I question even the humblest products and their value. For instance, why the heck do I need a razor which has five blades? How close can a razor get before it starts taking your face off anyway? Two blades are fine and the shaving foam I use now is a supermarket brand which is a third of the price of the branded equivalent and just as good. I don’t seem to be the only one either who is changing their ways either. Caroline Eveleigh at Anatec Software and Systems is doing the same with her lighting.

The main point is that we will soon have a great deal more ‘disposable income’ so that our family can invest in the really valuable things in life such as giving our children the best education we can, investing money for the long term, and actually having some fun.

And this is what we are doing in our business, of which I am now a part, too. We question the value of all of our investments very closely. We are investing in the skills of the team. We are investing in building relationships with our new and existing clients. We are making sure we have some fun as business too.

And as the tough conditions continue for businesses and people alike, it seems like their is change in the atmosphere in how people perceive their environment. Umair Haque wrote a very interesting article where he pointed out a change in society in a group which he calls ‘Generation M‘. Generation M is searching for greater meaning in a world which is “full of big, fat, lazy business” but which is seeking “small, responsive, micro-scale commerce“.

I am part of Generation M. I have moved out of big business and into small business where I can make a difference. I am glad that I am downsizing so I am no longer burdened with an oppressive mortgage. I don’t buy products which purport to make me a better human being because the brand tells me so. I am buying products which do a good job and no more. I am getting my life back and getting some meaning into it so that I can enjoy what I do, spend time with my family and friends and just enjoy a simpler life.

Tags: blogs, business, change, education, Finance, Five, generation m, lazy business, meaning, recession, relationships, skills, small business, strategy
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Books are Terminated in California

Arnie wants books digitised in schools

Recent news from California about Governor Arnold Schwarzenegger seeking to move all of the States school textbooks from printed versions to digital versions to save $350 million  came as no surprise this week. The State has practical reasons behind it. Namely, a $24.3 billion debt in their finances.

It then comes as no surprise to hear that Amazon will launch its new ebook device, the Kindle DX, this year which has a bigger screen and is aimed at the academic market which needs more ’space’ on the screen to accommodate the richer nature of school text books than novels. That’s good timing.

There are people who doubt whether there will be demand for ebooks, as illustrated in today’s article in The Bookseller, when novelist, Nick Hornby, voiced his opinion that people only buy books for reading on summer holidays. Hornby made sense but this is only one part of the market, of course.

Publishers continue to see the rise in sales of their digital products, such as ebooks and audiobooks. They are not yet in double digits as a percentage but they are growing and at a pace. Schwarzenegger’s announcement depressed Pearson’s share price and when 42% of the publisher’s sales come from the education market, it’s time for them to stop sucking the cash cow dry and switch to digital.

There are concerns over the price of some of the ebook reading devices, but when you consider that an academic textbook can cost between £40 and £55, and a reader device costs £300 to £400, local education authorities will soon be better off by providing digital versions of books, even if they are downloaded onto existing laptops or PC’s.

Tags: amazon, audioboo, books, business, devices, digital, ebooks, education, Finance, kindle, print, publisher, publishers, publishing, sales, textbooks
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Car Washing and Cash Flow

Start at the bottom to see realities

Received wisdom says that you should hand wash your car from the top to bottom. You start by rinsing your car and loosening off the dirt. Then you get a sponge, dip it into a bucket of warm water containing that special car shampoo and start to wash the top of the car and work your way down. The problem with this method is that at the end of the whole process you can see where you missed with the sponge by the scattering of dirty patches around the car. It’s infuriating. 

Much the best way to hand wash your car is to start washing it from the bottom to the top of the car. You can see exactly where you have washed or not and you don’t get fooled by by your soap suds dripping over patches of dirty bodywork making them look as though you have cleaned them. It seems odd and I have had occasional mocking rebukes from friends saying I am talking rubbish. But it works.

So, what the heck has this got to do with cash flow? 

Anyone who has ever run a business will know that cash flow is one of the most important aspects of financial planning to get right to enable your business to survive. Get your cash flow wrong and your business dies. You might have orders in the pipeline, purchase orders and sales coming in. But, if the cash is not coming in and cash is going out faster than it comes in then a business that looks profitable on paper will go bust quickly. (If you want an example of a near miss for a business that could have gone bust then read my earlier article about a small business I know that could have easily gone bust).

When you put together a cash flow forecast on a spreadsheet, received wisdom will, generally, tell you to start at the top of the spreadsheet with your sales and other income each month for the first year. You might even forecast your sales or the first few months on week by week basis . Then you are told to write out your variable costs (those costs which increase depending on the number of sales of your product or service that you sell) into the cash  flow forecast for each month. And, then you add in your fixed costs for each month such as your rent, broadband costs, and salaries, for example.

At the bottom of the spreadsheet, using some simple formulas, you subtract your fixed and variable costs for each month from your monthly forecasted sales income. This then gives you a figure of how much cash will come in and out of your business bank account each month. It shows you how much money you need to fund your business at the start-up stage. It is likely that your cash flow will show that more money will go out in the first few months of your business than will come in. This is very important to understand.

But it is wrong. 

By starting at the top with your sales income, you start the whole process of building your cash flow forecast on a false premise. A fantasy. Forecasting your sales income is the most difficult thing to do and starting at the top of the spreadsheet is a massive mistake. You will fall into the trap of entering sales income figures which look right rather than those that are possible. And when you finish putting together your cash flow forecast, you sit back and feel good because your spreadsheet shows that you have a great business idea which is going to make you lots of profits. You start your business full of cheer and six months later you wonder what happened to your great business idea as it collapses around you.

You can avoid this trap. You avoid it by putting together a cash flow forecast from the bottom up in the spreadsheet. Costs to your business are definite. Sales income is a ghost at this stage. You can find out exactly how much everything will cost you down to the last penny. Find a sense of interest and intrigue in discovering your costs to your business each month that others will find baffling. Because finding certainty in your costs is the only sure thing which you can do for your business finances at this stage. 

When you have done this and used your simple formulas to work out your fixed costs and the costs you will incur when you do sell a product, which will be your variable costs, you can begin to work out what you need to sell and when you need the cash to come in to cover your costs. When you know this, you can work out how you will get your sales. This is sales strategy. You can research your potential customers. You can ask them if they would buy your product. You can work out if your product or service is too expensive or too cheap. You can work out what else you will need to do to sell and market your product or service. 

When you know these highly important details, you will know whether your business idea is not just a good idea but something which you will be able to sell profitably. You will save yourself a lot of trouble and money too.  

And why should you believe me? Because I started a business with a cash flow forecast at the top of the spreadsheet and completely overestimated how much I could sell and underestimated when the cash would come in. The business went bust. It was painful but it taught me the right way to plan a business and its cash flow forecast.

So, when you are next planning  to start a business and you are planning your cash flow, take a few moments out and hand wash your car. But do it from the bottom to the top. You won’t miss anything then and you will see that the received wisdom of hand washing cars the other way round is wrong. And then go back inside and do the same with your cash flow forecast.

Tags: bankers, business, car wash, cash-flow, credit crunch, Finance, marketing, planning, sales, small business, strategy
Posted in business, marketing, sales | 3 Comments »