The Parable Of Assets, Liability And Equity

The Parable of Assets, Liabilities and Equity- Chukwuma Nwanze

A young man once asked his Father, what must I do to be asuccessful entrepreneur? His Father looked at him and with a big smile on hisface then beckoned on him to take a seat. As both men sat, his Father told hima parable.

There were two women, one with a degree from a reputableUniversity named Zeo and another named Zara who didn’t go to the University butlearnt the art of trading from her mother. Zeo and Zara set out to start-upbusinesses in their chosen fields. Zeo was a gifted Baker and set out to starta Bakery while Zara a very good cook set out to start a Restaurant. Beforedeparting from home, Zeo was given some money by her parents and also obtaineda loan from her best friend Zikora which was to be paid up in six months.Zara’s mother applied for a six month loan from her co-operative, sold some ofher possessions and gave the money she had put together to her.

Zeo chose to situate the Bakery in an upscaleneighbourhood where most of the residents appeared to live healthy lives asmost of them were seen jogging very early in the morning every day. She got aspace in a high street shopping mall and contracted a leading interior decorationcompany to help with the interior and exterior design of the Bakery she named “Zeo’s”.After finishing the interior and exterior design of the Bakery, Zeo set out tobuy Bakery equipment’s only to realise that she had spent more than she should haveon leasing and renovating/ upgrading the space where the Bakery was situated.Instead of buying new equipment’s, she resorted to buying fairly usedequipment’s. With the money she had left, she had a launch party where she andher very excited friends sang, danced and posted pictures on social media allnight.

Zara elected to open her restaurant close to a major busterminal in a densely populated part of town where hundreds of people took thebus on a daily basis. Her Restaurant named after her, served local delicacieswith the option to sit in and eat or take-away. She ensured her environment wasalways clean and made sure her sales girl was courteous to everyone who came tobuy a meal. Her investment in acquiring assets for use in the restaurant was minimalas she bought only the basics with the mind-set that she will buy moreequipment’s as the restaurant grew.

Both businesses started about the same time but threemonths into starting the Bakery, Zeo complained that her patronage was not asshe envisaged. Her friends always came around and she was more than happy togive them pastries and bread every time they were leaving and even when they decidedto buy, they bought on credit most of the time. Her oven started developingproblems and she was unable to produce on some days. She had issues with theservice charge at the shopping mall; the management of the mall wanted tocollect service fees upfront for a three months period going forward. Zeo wasdistraught, everything seemed to be falling apart. She had not repaid her loan,no money, no customers, faulty equipment’s and increasing administrativeoverheads were her new reality.

Zara was having a different experience. Her native jollofrice was the rave of the moment as customers from within and outside herlocality patronized her. She employed a “pay before service” philosophy. Hersales girl did the serving while she collected the money from the customer. Shehad repaid the monthly instalments on the loan her mother took on her behalf asand when due. Business was really good.

The young man appeared to be enjoying the story when hisfather asked him if he was able to extract any lessons from the parable. As hewas about to respond, his father motioned towards him and continued speaking.“To become a successful entrepreneur, you need to understand the role of Assets,Liabilities and Equity in the business” he said. He went on to explain what hemeant by Assets, Liabilities and Equity. The accounting equation (Assets=Liabilities+ Equity) truly sums it all. It suggests that assets can be acquiredeither through liabilities (debt) or equity or a combination of both. Assets can be referred to as resourcescontrolled by a business from which future economic benefits are expected toflow to the business. “Future economic benefits” from that definition refer tothe income generated by the business and it is safe to assume therefrom thatcash will flow to the business. Liabilitieson the other hand can be described as a “present obligation, arising from pasttransactions which when settled or paid will lead to an outflow of economicbenefit from the business’’. Equitycan be described as an “owners claim to a business’s net assets” and net assetsrefers to total assets less total liabilities. Equity is sometimes referred toas the cash or idea the owner of the business makes available to start up thebusiness.

Assets can either be acquired by way of debt (loans,borrowings from family and friends) or Equity (personal savings, inheritance,funds from partners etc). One of the principal things done with loans or equityis the acquisition of assets (note that for a start-up, debt and/or equity canalso be used for set-up costs). These assets are expected to generate income orenable income generation. It is this cash that is in turn used to settleexpenses that maybe incurred during the course of business or liabilities asand when they fall due. Excess cash can also be used in acquiring new assets, usedfor growing the business or even paid out as dividend to the owners of thebusiness.

Looking lost, the young man asked “Father, how does allthis relate to your parable”? His Father answered with the following points

  1. Themonies obtained by Zeo from her parents and the proceeds from Zara’s mother’spossession were equity in the business. Every start-up business needs equity asit shows a level of belief in the business idea or as some will say skin in thegame.
  2. Thesix month loan Zeo took from Zikora and the loan Zara’s mum took on her behalffrom the co-operative are Liabilities. These loans have cash flow implicationsas principal and interest will have to be repaid based on the terms of theloan. Start-ups and small businesses are encouraged to use more of equity atthe start and when the business starts generating a regular cash flow pattern,they can consider taking debt by way of loans if and only where necessary.
  3. Zeoand Zara used their debt and equity differently. While Zeo used her’s  for non-income generating assets leading topoor cash flows, Zara used hers wisely, spending wisely and being moredeliberate about getting the proceeds of her sales.
  4. Tobe a successful entrepreneur, you need more than talent. Zeo and Zara weregifted at what they did but the decision making required to manage a successfulenterprise was evidently better with Zara.
  5. Cashis the life-blood of any organization. Any business that is starved of cashwill find it difficult to operate whether in the short, medium or long term.Cash is used to fund day to day operations of the business, repay loans, settleoverheads, invest, acquire assets and at the right time pay dividends.
  6. Anunderstanding of your market and the interplay of product, price, promotion andplace (4p’s of marketing) are as important as the talent, capital and passionany entrepreneur possesses.

The Father asked his Son, is there any other lesson you have learnt? The son replied heartily, “business thrives when friends and family pay for goods and services”.

  • Post by Chukwuma Nwanze- Executive Director (Credit Direct Limited)

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