Many times people reach out to me to ask questions which stray from typical investments into the field of entrepreneurship. For example, someone asked me what were the returns they could make if they took a loan to buy a car for commercial purposes. Another asked if it was profitable to buy a motorized tricycle for waste management business.

Among the reasons why people seek to become entrepreneurs is the belief that investments such as stocks, fixed income or mutual funds do not generate adequate returns and therefore it is better to start a business instead of building a portfolio of passive investments. This thinking is not wrong since the returns of a successful business are theoretically unlimited while those of passive investments are usually stable and predictable within a range.

Apart from this thinking, there’s another argument that business is superior to passive investments because with a business you will “see money everyday.” This means that while a passive investment usually results in paper gains which are only realized when they are liquidated, a business will result in cash coming in each day. This is what I refer to as the cash flow illusion.

Cash flow refers to the inflow and outflow of cash into a business. Because most (small-to-medium scale) businesses receive revenue in the form of cash or bank payments each day, it can be tempting to think that this means that returns from business are superior to returns from investing, which only appear as figures on paper.

For example, let’s take the case of investing in a commercial vehicle. For simplicity we’ll assume you bought the vehicle outright for GH₵25,000.00 with no debt so you have no loan repayments to make. We’ll also assume you give the vehicle out to somebody in return for GH₵50.00 per day for 6 days a week. Below is the possible return from such a venture.

The reason why I am charging depreciation is so that we can make an accurate comparison with passive investing. If you put GH¢25,000.00 into a passive investment (treasury bills for example) you will still have that GH¢25,000.00 at maturity as well as the accumulated interest. However if you invest in a depreciable asset, the market value will fall over time and thus you won’t get the money you put in if you try to sell the asset.

Now 19.4% is a pretty decent return. But that is assuming no sick days, no time off for extended repairs and no taxes. Comparatively, you could make a return of about 16% risk free from 364-day treasury bills. However, this is where the cash flow illusion comes in and elevates the prospect of business over passive investment.

The cash flow illusion occurs when the presence of cash creates the impression of superior returns. It could be that a passive investment would return more but the fact that you have to wait until you liquidate the investment to realize your returns is turn off for some people. In comparison, if you know that you have money coming in everyday that could help with your expenses, you tend to see that as a much better investment even if a true analysis of the figures will show a different picture.

Going forward, I will be doing more market research to be able to analyse prospects of alternatives to passive investing as they have become a popular choice among people who reach out to me. But, for people who want to get started, do remember to keep the cash flow illusion in mind and not think that the frequency of cash inflow is equal to superior returns.