Staying Solvent, Staying Liquid: “The Micawber Principle”

| August 6, 2014

18545451_m“Annual income twenty pounds, annual expenditure nineteen [pounds] nineteen [shillings] and six [pence], result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.” So opined Wilkins Micawber in Charles Dickens great novel David Copperfield.

Mr. Micawber thus announced a principle of personal and business finance taught by professors, preached by accountants, and often ignored by business owners – that financial solvency and liquidity are not only essential to successful operations, but also are very important to your peace of mind and sense of fulfillment in your business endeavors. You should always operate your business at a standard below your revenue, and always live at a standard below your income (“result happiness”). Spending just a few dollars (or a few pence) more than your income can turn a stable situation into a stressful one (“result misery”).

The best management and financial consultants (both Christian and secular) take turns restating Mr. Micawber’s principle in their own way.

“Whatever your income, always live below your means” wrote Thomas Stanley in The Millionaire Next Door; to which he added “Wealth is more often the result of a lifestyle of hard work, perseverance, planning, and, most of all, self-discipline.”

Dave Ramsay coaches to “act your wage” and has a board game to help you play it out.

Jim Collins in his book Great By Choice identified the characteristics shared by the great entrepreneurs of our time, among which was a “productive paranoia” – building in cash reserves and financial buffers to provide liquidity. Bill Gates famously required Microsoft (from its earliest days) to have enough cash on hand to be able to operate an entire year with no revenue; and so built a company that was super-solvent and super-liquid and could be super-responsive in the ever changing technology industry.

Solvency and liquidity are not the same thing. Solvency is the ability of the business to meet its long-term financial obligations, and to fund long-term business investments. Liquidity is the ability to meet short-term obligations and respond to immediate opportunities. If a company is not solvent it cannot survive in the long run. If a company is not liquid, it will be paying heavily for cash (in the form of interest), will be poorly equipped to meet unexpected expenses, and will miss many opportunities.

Liquidity is especially important to entrepreneurs and small businesses. The biggest advantage that small businesses have over their larger counterparts is the ability to make decisions quickly and decisively, and so to take advantage of new opportunities. But that decisive action usually requires liquidity; and for most small business owners, their more valuable asset (their business) is also the least liquid asset they have.

Therefore, small business owners especially have to learn and live by the Micawber Principle – intentionally living below your means with the purpose of building both a solid net worth and liquidity. It has been said that if a small business cannot live by the Micawber Principle, no other financial advice will matter, regardless of how sophisticated it may be.

Imbedded in the Micawber Principle are simple but powerful financial realities. First, little margins matter. The difference between “result happiness” and “result misery” is just 12 pence.

Second, direction is more important than speed. Small steps in the right direction will get you where you are going, and smooth the way in the days of unexpected bumps.

Third, as you gain equity, move towards full investment with available secured borrowing to maximize both your investment return and your liquidity. Today, equity lines of credit are available against both home and investment assets. If “cash is king” then the line of credit is queen. Use a line of credit only to take advantage of new investments with positive cash flow (rather than long term capital returns). Avoid debt that will cut into your regular business or household cash flow.

Finally, remember that Christian giving should be considered as spending – it is not a financial investment. Many Christians wrongly believe that giving is an investment that the Lord will repay in a financial way. This is neither Biblical nor true. Giving is very important and deserves a high priority in your budget, but it is not a means to a guaranteed return. Indeed, if we give to receive back again, we are no better than the “sinners who lend to sinners to receive as much back.” Rather we should be generous “hoping for nothing in return” (Luke 6: 34, 35)

In David Cooperfield, Mr. Micawber could never live within his means and repeatedly violated the principle that today bears his name. We do well to honor the wisdom of the Scripture that “There is treasure … and oil in the dwelling of the wise; but a foolish man spendeth it up.” (Proverbs 21:20).

Category: Finances