9 Financial and economic literacy
9.1 Introduction
Making money and becoming rich are concepts that we easily associate with entrepreneurship. This is not so strange when you see that the top 10 richest people in the world is dominated by entrepreneurs like Elon Musk, Jeff Bezos, Gautam Audani, Bernard Arnault and Bill Gates. But what role does financial and economic insight actually play in entrepreneurship? Are successful entrepreneurs really better at handling money, or did they simply employ good accountants? To what extent do we lay the foundations for financial and economic literacy in education? To start with the latter question: what is clear is that the age at which students must start taking financial decisions, for example with regard to their education, insurance and methods of payment, is steadily falling. Also, a lot has changed in the past ten years when it comes to money and finance in a broader sense: think about paying with your smartphone and the rise of blockchain and crypto currencies such as bitcoins. Unlike in some other countries, financial literacy is not a separate subject taught to young people in the Netherlands. This does not mean that school is not an important place to learn about how to develop financial literacy. More and more schools are setting up projects such as 'money week', and guest lectures on 'dealing with money' are also becoming more common. Teachers include such topics within the subject of social studies, others within subjects such as economics and business economics. And that has an effect! According to PISA, the international comparative study conducted under the leadership of the OECD International, the Netherlands does quite well when it comes to the financial literacy of its young people. But is that enough when it comes to financial and economic insight in the context of business? More on that below.
9.2 Insights
Although they are related, it does make a difference whether you are talking about financial literacy in the private sphere or in the context of entrepreneurship. With regard to entrepreneurship, the OECD distinguishes four different contexts that make different demands on the financial literacy of entrepreneurs [1]. The first context is that of "latent entrepreneurship", the context we talk about a lot in this book. You have ideas, those ideas might become entrepreneurial projects for which you need money to start them up, and you possibly already manage them a bit. If those projects acquire the status of a formal start-up at a certain point, the financial context changes. After all, the idea then becomes a company, and with that you become liable for tax. The basic financial knowledge you need as an entrepreneur increases again. If the business then starts to grow and staff are taken on, the financial complexity increases again (think salaries, other legal forms). The final, fourth financial context that demands financial insight from the entrepreneur is that of closing down or selling a business. The context of 'entrepreneurial projects', with an oblique view to that of the start-up, is the context that is most relevant in this book, it concerns in particular:
Financial insight
The literature strongly emphasizes the importance of financial acumen for entrepreneurs, although there are surprisingly few scientific studies on the relationship between financial acumen and success in Western economies. The majority of scientific studies on this subject have been conducted in non-Western contexts. A 2016 study by the Dutch Chamber of Commerce shows that financial literacy is not a given. It conducted research among more than 1,600 self-employed individuals and SMEs, who were asked to estimate their own financial knowledge [2]. It showed that about half of the entrepreneurs were not very confident about their own financial knowledge of tax laws, income tax, the basics of the balance sheet and profit and loss account, and figures needed for a profitability forecast. There also seemed to be a correlation between the level of knowledge of the entrepreneur and the financial performance of the business. So while sorting out the finances is often not the hobby of the average entrepreneur, accounting and administrative knowledge and skills are indeed important for entrepreneurship.
Funding of project
This research also showed that entrepreneurs feel more financially capable at the operational level (basic administrative and accounting knowledge) than at the strategic level (e.g. seeking finance). One of the biggest challenges entrepreneurs face in the latent and start-up phase - when they do not yet have a company or other form of formal organisation - is financing the idea or project. After all, why would anyone want to put money into it? In some sectors, especially innovative ones, entrepreneurs spend a lot of time trying to find (additional) funding to get their entrepreneurial project up and running. Legitimacy, or rather lack of legitimacy, is a major reason why many entrepreneurial ideas and projects fail to get off the ground. No bank wants to put money into a project for which there are no financial figures, and which does not yet generate money of its own. So as a lender you have to have a lot of faith in the person to put money in it. The entrepreneurship literature jokingly refers to the three F's of financing, namely that of Family, Friends and Fools [see also: Mobilising resources].
Forms of financing
International research shows conclusively that the most important source of funding for entrepreneurial ideas and projects is... the entrepreneur himself. But, as mentioned, the financial landscape has also changed in recent years. There are more opportunities for funding nowadays, especially if your idea is more advanced, and if you can show that it works (proof of principle) and that there is demand for it (traction). In addition to banks starting to offer alternative products, there are many alternative non-bank ways of obtaining money. Think of business angels, venture capitalists, incubator programs, corporate venture capital (the start-up playgrounds for large companies) and especially crowdfunding [3]. Interestingly, research shows that these (co)financiers pay attention to very different things than banks do, when they look at entrepreneurs. They also play a different role in financing entrepreneurial projects and start-ups. Where banks mainly look at the financial picture and the availability of collateral, business angels and venture capitalists pay much more attention to the market side (is there a demand for the idea?). Business angels pay much more attention to the person. This is not so strange, because business angels are often former entrepreneurs who have earned their stripes over the years and who want to share their knowledge and experience with the entrepreneur in whom they want to invest. When it comes to blended value creation [see: Valuing ideas], crowdfunding becomes more important. Crowdfunding is characterized by raising money through the general public. On an internet platform you tell as many people as possible about your plans and ask them whether they want to invest some money in it. Research shows that it are mainly young, highly educated, broad-minded, non-conservative people who put their money in sustainable crowdfunding ideas and projects [4]. The lesson that can be drawn from this is that for funding an entrepreneurial project, idea or start-up it is extremely important to find the right match between 1) the ambitions/competencies/wishes of the entrepreneur 2) the nature/stage of the idea and 3) specific characteristics of the funder.
- Operational knowledge and skills such as administrative and accounting knowledge and skills, and financial planning and budgeting;
- Strategic knowledge and skills such as financing an idea and understanding the (changing) financial landscape.
Financial insight
The literature strongly emphasizes the importance of financial acumen for entrepreneurs, although there are surprisingly few scientific studies on the relationship between financial acumen and success in Western economies. The majority of scientific studies on this subject have been conducted in non-Western contexts. A 2016 study by the Dutch Chamber of Commerce shows that financial literacy is not a given. It conducted research among more than 1,600 self-employed individuals and SMEs, who were asked to estimate their own financial knowledge [2]. It showed that about half of the entrepreneurs were not very confident about their own financial knowledge of tax laws, income tax, the basics of the balance sheet and profit and loss account, and figures needed for a profitability forecast. There also seemed to be a correlation between the level of knowledge of the entrepreneur and the financial performance of the business. So while sorting out the finances is often not the hobby of the average entrepreneur, accounting and administrative knowledge and skills are indeed important for entrepreneurship.
Funding of project
This research also showed that entrepreneurs feel more financially capable at the operational level (basic administrative and accounting knowledge) than at the strategic level (e.g. seeking finance). One of the biggest challenges entrepreneurs face in the latent and start-up phase - when they do not yet have a company or other form of formal organisation - is financing the idea or project. After all, why would anyone want to put money into it? In some sectors, especially innovative ones, entrepreneurs spend a lot of time trying to find (additional) funding to get their entrepreneurial project up and running. Legitimacy, or rather lack of legitimacy, is a major reason why many entrepreneurial ideas and projects fail to get off the ground. No bank wants to put money into a project for which there are no financial figures, and which does not yet generate money of its own. So as a lender you have to have a lot of faith in the person to put money in it. The entrepreneurship literature jokingly refers to the three F's of financing, namely that of Family, Friends and Fools [see also: Mobilising resources].
Forms of financing
International research shows conclusively that the most important source of funding for entrepreneurial ideas and projects is... the entrepreneur himself. But, as mentioned, the financial landscape has also changed in recent years. There are more opportunities for funding nowadays, especially if your idea is more advanced, and if you can show that it works (proof of principle) and that there is demand for it (traction). In addition to banks starting to offer alternative products, there are many alternative non-bank ways of obtaining money. Think of business angels, venture capitalists, incubator programs, corporate venture capital (the start-up playgrounds for large companies) and especially crowdfunding [3]. Interestingly, research shows that these (co)financiers pay attention to very different things than banks do, when they look at entrepreneurs. They also play a different role in financing entrepreneurial projects and start-ups. Where banks mainly look at the financial picture and the availability of collateral, business angels and venture capitalists pay much more attention to the market side (is there a demand for the idea?). Business angels pay much more attention to the person. This is not so strange, because business angels are often former entrepreneurs who have earned their stripes over the years and who want to share their knowledge and experience with the entrepreneur in whom they want to invest. When it comes to blended value creation [see: Valuing ideas], crowdfunding becomes more important. Crowdfunding is characterized by raising money through the general public. On an internet platform you tell as many people as possible about your plans and ask them whether they want to invest some money in it. Research shows that it are mainly young, highly educated, broad-minded, non-conservative people who put their money in sustainable crowdfunding ideas and projects [4]. The lesson that can be drawn from this is that for funding an entrepreneurial project, idea or start-up it is extremely important to find the right match between 1) the ambitions/competencies/wishes of the entrepreneur 2) the nature/stage of the idea and 3) specific characteristics of the funder.
9.3 Further reading
[1] In 2018, the OECD defined the core competencies for financial literacy of self-employed, SME and budding entrepreneurs. In doing so, they build on the 2016 framework for youth financial literacy. OECD (2018), OECD/INFE Core competencies framework on financial literacy for MSMEs. OECD-INFE-core-competencies-framework-on-financial-literacy-for-MSMEs.
[2] The study by Yan Alperovych and colleagues is the scientific version of the 2016 CoC study. Alperovych, Y., Calcagno, R., & Lentz, M. (2020). Entrepreneurs on Their Financial Literacy: Evidence from the Netherlands. CeRP, Center for Research on Pensions and Welfare Policies.
[3] This review article by Joern Block and colleagues discusses the changing financial landscape, what players exist, and how they differ. Block, J. H., Colombo, M. G., Cumming, D. J., & Vismara, S. (2018). New players in entrepreneurial finance and why they are there. Small Business Economics, 50(2), 239-250.
[4] Isabel Tenner and Jacob Hörisch recently looked at the characteristics of crowdfunding investors, particularly when it comes to crowdfunding for sustainable development. Tenner, I., & Hörisch, J. (2021). Crowdfunding sustainable entrepreneurship: What are the characteristics of crowdfunding investors? Journal of Cleaner Production, 290, 125667.
[2] The study by Yan Alperovych and colleagues is the scientific version of the 2016 CoC study. Alperovych, Y., Calcagno, R., & Lentz, M. (2020). Entrepreneurs on Their Financial Literacy: Evidence from the Netherlands. CeRP, Center for Research on Pensions and Welfare Policies.
[3] This review article by Joern Block and colleagues discusses the changing financial landscape, what players exist, and how they differ. Block, J. H., Colombo, M. G., Cumming, D. J., & Vismara, S. (2018). New players in entrepreneurial finance and why they are there. Small Business Economics, 50(2), 239-250.
[4] Isabel Tenner and Jacob Hörisch recently looked at the characteristics of crowdfunding investors, particularly when it comes to crowdfunding for sustainable development. Tenner, I., & Hörisch, J. (2021). Crowdfunding sustainable entrepreneurship: What are the characteristics of crowdfunding investors? Journal of Cleaner Production, 290, 125667.
9.4 Exercises for students
1) Analysis of business plans
In groups, students receive a fully anonymized business plan, with the assignment to screen the financial section. What do they notice? What do they stumble over? Would they put their money into it as potential financiers?
Explanation: This assignment is a good way to introduce students to financial concepts in a business plan.
2) Analyse pitches from entrepreneurs
There are many programs on television nowadays in which entrepreneurs have to pitch for investors. Think of the popular Dragon's Den. Students watch a pitch and think about whether they themselves would put their money in it.
Explanation: Analysing pitches for investors, including the questions that investors themselves ask, provides insight into what is important and found in entrepreneurial projects.
3) Analysing your own pitches
Students come up with their own ideas in groups, and as a teacher you state the total amount of money that is to be given away in advance. Then you and the groups decide how much money the individual ideas will receive. Afterwards it is determined on the basis of which (financial) criteria the ideas received money.
Explanation: This assignment goes one step further. What (implicit) assessment frameworks do students use as potential funders when assessing pitches?
4) Crowdfunding/Instagram assignment
This assignment will take 45 minutes to complete. Preferably do it before a break. The evaluation (who was the winner and why) can be done one day, several days or up to a week later.
Explanation: This assignment demonstrates the power (and challenges) of crowdfunding and is an activating, experiential assignment for students. For teachers, it is important to create a Bit.ly account to track students and to show students in the evaluation which group generated the most likes and traffic to its chosen project. It is also important to discuss why specific projects were chosen and what the financial risks of the project are.
In groups, students receive a fully anonymized business plan, with the assignment to screen the financial section. What do they notice? What do they stumble over? Would they put their money into it as potential financiers?
Explanation: This assignment is a good way to introduce students to financial concepts in a business plan.
2) Analyse pitches from entrepreneurs
There are many programs on television nowadays in which entrepreneurs have to pitch for investors. Think of the popular Dragon's Den. Students watch a pitch and think about whether they themselves would put their money in it.
Explanation: Analysing pitches for investors, including the questions that investors themselves ask, provides insight into what is important and found in entrepreneurial projects.
3) Analysing your own pitches
Students come up with their own ideas in groups, and as a teacher you state the total amount of money that is to be given away in advance. Then you and the groups decide how much money the individual ideas will receive. Afterwards it is determined on the basis of which (financial) criteria the ideas received money.
Explanation: This assignment goes one step further. What (implicit) assessment frameworks do students use as potential funders when assessing pitches?
4) Crowdfunding/Instagram assignment
This assignment will take 45 minutes to complete. Preferably do it before a break. The evaluation (who was the winner and why) can be done one day, several days or up to a week later.
- Work in groups of 3 students.
- Each group chooses a crowdfunding project they would like to support on the Oneplanet Crowd platform, www.oneplanetcrowd.com/nl/projects.
- The group argues the choice of the project (why this project?).
- The groups will pass on the web link of this project to teacher.
- The teacher then provides a Bit.ly link for the challenge (Bit.ly is particularly useful because extensive statistics are available on the use of the link. For this the teacher has to create an account via the option 'Sign up').
- The group designs a photo calling for support for the chosen project, and incorporates the Bit. ly link.
- The group shared this photo via Instagram.
- Once it's break time, the group tries to create as many likes as possible with the photo.
- The group that generates the most likes for its photo and the most traffic to its chosen project wins this challenge.
Explanation: This assignment demonstrates the power (and challenges) of crowdfunding and is an activating, experiential assignment for students. For teachers, it is important to create a Bit.ly account to track students and to show students in the evaluation which group generated the most likes and traffic to its chosen project. It is also important to discuss why specific projects were chosen and what the financial risks of the project are.