Capital, businesses most critical resource

You need capital to start most businesses.

Capitalise your business properly or suffer the consequences 

Positive working capital is required to ensure a business is able to continue its operations and that it has sufficient funds to satisfy both maturing short-term debt and impending operational expenses. The management of working capital involves managing inventories, accounts receivable, accounts payable and any cash.

Disposal of non-performing assets can also release cash. A business can be endowed with assets and be making lots of profit but can be short of liquidity if its assets cannot readily be converted into cash. 

Whether you’ve been in business one week or twenty years, an infusion of new capital is always welcome. But what is best for your business? Become more financially savvy, There are so many factors to consider, from the development stage of your business, to what type of finance you need to consider and knowing what to do and how to do it can be quite overwhelming.

Can you answer these questions?

Having the right kind of capital to operate effectively and grow your business is arguably one of the most important responsibilities you have as a manager or business owner.

Your failure to understand how to capitalise a business can quickly put it at risk. It is critically important you understand the intent and implications of the following questions:

  • If your business is not properly capitalised, why isn’t it?
  • Can you properly capitalise your business and how long it will take?
  • Do you know how to determine current and future capital requirements?
  • Do you understand what ‘working capital’ means and how important it is?
  • Have you structured your capital in order to maximise cash flow?
  • Have you ever had to manage and allocate funds in proper proportion?
  • What are the various sources of capital available to you?
  • Did you know you can actually grow, or sell yourself out of business?
  • Do you understand that the more successful you are and the more you grow the more capital you need?
  • What differences and what is the impact of ‘investment capital’; ‘retained earnings’ and ‘borrowed funds’ on the business?
  • What additional capital is required just to stay in business beyond what was necessary to start the business?
  • Do you understand how debt can get you into trouble?
  • Borrowing from family and friends can destroy relationships, are you avoiding the temptation?

Capital comes from three main sources

Investment Capital

This capital comes from you or some other investor. It’s like buying stock in a publicly traded company, except for one thing. When you make an investment in a small, closely held business, there is no after-market for your shares. Therefore, you typically won’t get your invested capital out until you sell the company. Consequently, it’s common to see a relatively small amount of investment capital on the balance sheet of most smaller businesses.

Borrowed Funds

This is debt, money you borrow from a bank or another source. Debt is not only an excellent way to capitalise your company, it is the capital that will make it grow if used appropriately. Uncontrolled debt can be a quick road to ruin.

Retained Earnings

This is the profit your company has made that you left in the business. It is the profit you didn’t take out as salary, bonus, dividend, or other distribution. Of all the forms of capital your company could have, this is the best kind, because your business acquired it by earning it. Every dollar of profit you leave in your business as retained earnings is another step toward financial security, even if it is a slow process.

Your financiers will like seeing retained earnings on your balance sheet, even more than investment capital, because it says two things about the business

  1. Your business had the ability to produce retained earnings by operating profitably.
  2. As the owner, you had the discipline to leave this capital in the company instead of distributing it, knowing that it takes more capital to grow the business.

Working capital

If you are going on a trip, you need enough petrol to get there. Operational efficiencies and better working capital management will drive profitability, facilitate growth, and reduce risk while improving sustainability. Working capital improvements provide a genuine way to overcome your cash flow strain and sleepless nights.

Your decisions relating to working capital and short term financing are referred to as working capital management. These involve managing the relationship between a business’s short-term assets and its short-term liabilities.

The goal of working capital management is to ensure that the business is able to continue its operations and have sufficient cash flow to satisfy both maturing short-term debt and upcoming operational expenses.

Use debt as a last resort

While debt is an excellent way to capitalise your business it can also get you into trouble, if the interest rate is too high, or if it is not carefully managed. You need equity, not all debt.

An inexpensive loan, however, can relieve stress and pressures on the business. This, in turn, should offset any interest costs by helping to increase productivity.

Without the right working capital, a business can  at risk, something often overlooked. Like a car without petrol, there is no progress, no matter how good the car might be.

Well managed can be beneficial

It’s a good idea to establish a line of credit for your business well before you need it. It is always more difficult to borrow when you are going through a cash crisis It can take a time to organise loans with a good interest rate. Loan sharks move in when you are desperate.

Pay back debt in accordance with loan terms to keep your credit rating in good standing. If you do have difficulty with repayment, contact the lender to renegotiate terms. Never leave it to the last minute. Good budgeting practices should show your cash requirements several months ahead with some degree of accuracy.

Credit cards as a line of credit are usually quick to arrange, but more expensive than loans from a bank. Your objective is to get what you might need at the lowest rate. Be careful about borrowing large amounts, or allowing your debt to build up where there are high-interest rates.

There are two things about borrowed money that should not be overlooked. Unlike investment capital or retained earnings, debt accrues interest to the lender and must be serviced. Repayments can create an incremental drain on your business’s liquidity. Your business has to be able to generate the profitability and subsequent cash flow in order to make these repayments.

Determine your business’s capital requirements

Firstly, you must know just what you are going to sell and how much you’re going to purchase, along with allowing for credit policies and collection rates, increasing inventory levels, operating expenses and any equipment acquisitions.

All of this has to be budgeted carefully with appropriate timelines. Your budget should show up any negative numbers which represent the new capital required and when you need it to be available.

Don’t deplete operating cash by purchasing larger capital items, especially with interest rates so low. Try not to borrow money for operating expenses; these should be funded directly from profits each month. Obviously, you will need to make some borrowings in a start-up situation for expenses whilst cranking up the sales.

Fund receivables and inventory arising from growth with borrowed capital as it is often impossible to fund growth purely from profits. It is a good idea to have a long-term plan to fund growth more from retained earnings and less from debt.

From a business perspective, business formation and growth is about access to capital. In order for businesses to access capital, three things are required from the perspective of potential investors:

  1. A good business model, business plan, budget and well-presented business case.
  2. The right investment environment with acceptable perceptions of risk and returns.
  3. Investment security, what will you offer as collateral?

What can you do to improve your capitalisation?

  • There are formulas for most types of businesses to show how much is needed.
  • Increase your borrowings.
  • Extend your supplier’s terms of trade.
  • Collect money owing to you quickly.
  • Improve your profit margins.
  • Lease or rent instead of paying cash. It’s usually better to put your available cash into making more profits and improving the operations of the business.

Ensure your business has enough of the right kind of capital in order to operate effectively and grow. US President Harry Truman had a now-famous plaque on his desk that read, “The buck stops here!”

Quotable quotes

“Life is a process of accumulation. We either accumulate the debt or the value, the regret or the equity”. Jim Rohn

“The surest way to ruin a man who does not know how to handle money is to give him some”. George Bernard Shaw

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