"What Businesses Actually Have the Best Cash Flow?"

0:00And so what do you look for when you're you're acquiring a business or investing in a business that has cash flow and what businesses have the best cash flow? >> So this will be relevant for everybody in the audience and also hits on what we were talking about with the wealth thing like wealthy people choose [clears throat] higher leverage opportunities and we went over what leverage was earlier. The best businesses especially in an inflationary period are businesses that have low capital expenses. >> Okay. >> And that's because if >> have some examples? >> Yeah, yeah. So if I'll give you opposite examples to make and then it I'll drive it. So the something that does have high capital expense which is what you would not want to get into would be like stuff that has lots of inventory, stuff that has lots of supply chain, lots of manufacturing, heavy equipment, things where you have to constantly buy more stuff in order to increase capacity, right? A low capital expense business are things like services, right?

0:45Services, you know, digital businesses, software is mixed cuz sometimes the development team can be considered a capital expense. It really depends on how you build the dev team. But the idea is that if you can produce 10 times more units without phenomenally changing the the cost basis then you will have a business that has lower capital expenses. >> Yes and so that's what you like and most of those types of businesses produce more cash flow, have more pricing power and so I mean that's what Warren Buffett invests in, right? It's high cap, you know, like um

1:17>> Insurance, Geico. >> Right. >> There's no capital it's risk. They're literally assessing >> Risk. >> Air. >> It's it's math. Like the business is math. Like if you really think it's just math is the entire business of insurance. And what's crazy it is a side note that a great way of figuring out the highest leverage businesses that exist is looking at the businesses that have been here the longest. >> Mhm. >> Insurance has been here since before World War World Wars. >> Right. >> Bank the banks have been around forever, right? JP Morgan was around 1800s, right? The the biggest insurance companies they're all 100 plus years old. They're they're founded in 1800s.

1:50And so when you have a business that's lasted that long to me that's a great breadcrumb of like this thing has to print money because it means that they were able to still keep making money through wars, through famines, through depressions, all of it, and they were still able to keep going. And so I think that when people are like when you look at all the like many of the biggest businesses that exist, they have phenomenal gross margins. I don't want to get too like, you know, business termy here, but like the the gross margin is how much incremental cost it is to make a new an extra widget, right? And so like a pill, for example, costs $100 million to make the first pill. And then every pill after that costs a penny.

2:26Right? Sure. And so the the gross margin on the pill is very high cuz if they sell each pill for $10, they cost them a penny, those are great margins. And most people who are small business owners or people who are trying to get into small business price like small business owners. They say, "Well, it costs me a dollar, I'll sell it for three. Or I'll sell it for two." But if you're already starting on like a 50% gross margin, it's very, very hard to make money cuz think about like that's at 100 you're already at half, and then you have the rest of everyone else you have to pay off that extra 50. Very hard to do. And so like I'll give a couple rules of thumb if anyone wants this, but like if you're if you're building a service-based business for us, I would I by all means I have to get gross margins above 80%, which means five times the the cost of goods. So if it costs me $100 a month, the minimum I'll charge is 500.

3:10Right? And so that also gets you to to think about business differently, which is not necessarily even how much can I charge, but how can I provide value and make it cost as little to me? How can I be as efficient as possible? And if you think about what technology does over time, is technology takes something that's valuable and makes the cost of delivering it less. And so that's what happens is a lot of people are able to have access to things that were once only for the wealthy, but now become for the common man because the cost basis decreases as a result of technology. And so technology as we see it, you know, like we can create technology, but you can also have technological breakthroughs just through process in your own business. It's like And that's where niching down and being very specific about the avatar becomes important, especially when when starting, because then you can productize the service. Because if you're doing everything custom, which most people when they're starting out do, it becomes really difficult to become efficient. And if it's really difficult to be efficient, you have very little margin, right? Or you have to charge huge fees, which most people are too afraid to do. And so, the flip side is, if I do the same thing over and over and over again, I will get better and more efficient at it, and I'll know how to do it faster and quicker and cheaper.

4:10And I specifically choose this type of customer so that I can have more margin because there are millions of even this one specific type of avatar. >> Mhm. >> And then from there, I can take the gross margin, the extra cash that I have, and I can hire the best people. I can invest in marketing. But when you have such little margin to work off of, it's very difficult to make money. >> Yeah, it's so hard to grow.

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