Three fundamentals of small business capitalization
The first sentence in the job description of every CEO should be, “Get the capital your company needs.”
Webster defines business capital as, “any asset, tangible or intangible, that is held for long-term investment.” Capital blended with operating cash flows becomes the financial fuel your company’s engine uses to operate with and fund growth.
A small business has three primary sources of capital:
• Investment Capital — from you or someone else.
• Retained Earnings — profit you had the discipline to leave in the business.
• Borrowed Funds — for most small businesses, from a bank loan.
Every once and future small business CEO must be able to must deal with capitalization issues, including the following three prime capital fundamentals.
Capital requirements
Additional capital is required just to STAY in business beyond what was necessary to START the business. And the stay-in-business capital is much more than the get-in-business capital. Success begets growth and growth eats capital like Cookie Monster eats chocolate chip cookies. So without a capitalization plan, you can grow yourself out of business.
You must know how much you’re going to sell and how much you will spend on inventory, operating expenses, equipment, training, etc. Then you have to estimate the capital required to cover the gap between how long it will take to collect from customers, and how quickly you’ll have to pay suppliers. An essential practice is to project cash flow over 12-months; any negative numbers at the bottom of a column represent the extra capital you will need when you need it and for how long.
Capital allocation
Here are three capital allocation guidelines. Don’t use operating cash to purchase assets. Don’t borrow money for operating expenses. Funding growth with borrowed money is okay if you have a plan to convert growth funding from debt to retained earnings.
Retained Earnings
This is the working capital you don’t have to borrow from a bank or dilute ownership with investors. It’s your safety net during inevitable periods of slow sales or other problems. And it’s your financial homerun when you sell your business. Unfortunately accumulating retained earnings is slower than most desired growth goals. Every dollar of profit you leave in your business as retained earnings is a step toward financial security.
Write this on a rock … As the CEO or your business, it’s your job to acquire, manage, allocate and maximize all sources of capital.
Jim Blasingame is creator and host of the Small Business Advocate Show. Copyright 2014, author retains ownership. All Rights Reserved.
