Where do business returns come from?

Whether you’re an entrepreneur, business leader, or investor, it helps – actually, scratch that. 

Let’s start again:

Whether you’re an entrepreneur, business leader, or investor, it’s essential to understand where business returns come from. I speak to business students all the time and most of them can’t describe where business returns come from.

But if you ever hope to become business rich, you can’t avoid this knowledge. It impacts everything from how you design your business model to how you ultimately run your business.  And if you’re looking to buy shares from a publicly traded company? Not knowing where business returns come from makes you a “non serious” stock picker versus an investor who thinks like an owner.

So let’s talk about business returns and get you into that serious-business-owner mindset.

The elements of business returns

At their highest level, the elements of business returns are just the cash you pay out to investors plus the changes in value of their equity investment.

The elements of business returns = 

Cash Payout + Changes in Value of Investment

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If you’re just starting a business, you’ll want to use Equity Creation Cost as your metric. That makes your dividend yield the amount of cash you pay out per share as a percentage of your per share equity creation cost. If your company is established, you may know what your equity per share is valued at.

And it’s even easier with a publicly traded company. That would make your investor dividend yield, the cash flow distributed per share as a percentage of its market share price.

But how do businesses grow in value? It all comes down to Cash Flow Per Share Growth.

Cash Flow Per Share Growth

It’s important to note that I’m not talking about earnings growth here (though it certainly tends to accompany Cash Flow Per Share Growth). That’s because “earnings” are an accounting concept while “cash flow” is a financial concept. And it’s financial results, not accounting results, that are at the heart of wealth creation.

This is something every entrepreneur understands: If your business cash flow per share never grows, neither will your share values.

Cash Flow Growth Per Share is centered in business models and comes from two different sources:

1. Internal Growth: growth that can be realized through a company’s own resources
2. External Growth: growth that’s enabled by raising new money through investors

Businesses will seek to add shareholder money when they can’t fulfill their growth through internal resources alone.

Understanding internal and external growth sources

There are two internal sources of cash flow growth per share available to business leaders. The first of these is Same Store/Same Business Line Sales Growth. Basically you grow your cash flow per share by selling more of whatever it is you make with the same resources you started out with. The second internal growth source comes from reinvested free cash flow into expansion. This happens when, rather than distribute your free cash flow to all your investors, you retain some or all your cash, reinvesting into your company to fund its expansion.

This provides new resources to realize additional product sales that generate added cash flow. Reinvesting cash flow into new resources to enable expansions, allows investor business returns to compound, and it’s what many of the finest growth companies do.

But maybe your company could grow faster if only you had more money. And that’s where external growth comes in. The idea behind external growth is to issue added shares of stock to existing or new shareholders to further boost your per share cash flow growth.

How to estimate business returns

Once you know your company’s dividend yield and the per share cash flow growth from your internal and external drivers, you can estimate investor returns by adding all those numbers. It’s that simple.

The Gordon Constant Growth Formula is a useful math hack that basically adds your equity dividend yield to the cash flow per share growth rate to arrive at your total expected rate of shareholder return.

Gordon Constant Growth Formula

Dividend Yield + Per Share Cash Flow Growth Rate

= Expected Total Return

Assuming constant cash flow per share growth is a simplistic, but insightful assumption. In our case, add the dividend yield to the combined cash flow per share growth rate divided by:

1. Per Share Cash Flow Growth from Sales Store/Same Business Line Sales Growth
2. Per Share Cash Flow Growth from Sales from Reinvested Cash Flow into Expansion
3. Per Share Cash Flow Growth from New Equity Issuance to Enable More Expansion

Establishing successful business returns

Assuming you’ve created a company from scratch and the expected shareholder return from your full return sources exceeds investor return requirements, then you can consider your business to be financially successful. In other words, your business will be worth more than what it cost to create. 

4 Basic Business Return Sources > Investor Return Expectations

= Wealth Creation

And that will unleash the fifth source of business return – a wealth turbocharger – that can turn entrepreneurs into millionaires overnight.

Join me here, and on my YouTube channel so you don’t miss out.

(But if you need to skip ahead quick, grab your copy of The Value Equation now.)

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