What Does Capital Mean To You?

And, no, as you read this I am not referring to your capital city!

In accounting jargon, capital (net worth) is quantified simply as assets minus liabilities.  It is the measure of how much your assets exceed your liabilities.  I said for many years as a small business banker that capital measured your ability to withstand losses and support growth.  Why is this important?

As an aside, you have read in some of my columns that many in our industry for a plethora of reasons are undercapitalized.  Regardless of how you got there, it is not good for the future of your business.

Without capital, you cannot grow.  Quite possibly you cannot meet your maturing financial obligations either.  Working capital is defined as current assets (those maturing within twelve months) minus current liabilities.  That also needs to be positive.

The make up of your assets also affects your financial prowess.  If you are inventory heavy, that is not easily converted to cash.  If your accounts receivable are not as collectible as in the past, then your calculation of working capital and capital may be giving you a false sense of security.

Need equipment to grow?  Either you have the free cash or you can borrow from your bank or another lender.  Both require capital.

Adding a new inventory line?  You need capital to support it or a very friendly bank.

There is a good prospect of increasing sales?  You need capital to support that increase.  Yes, your trade creditor can provide some support.  So can your bank or factor.  But come Friday, you need to meet payroll.  “Judges often are lawyers who could not meet payroll.”  They prefer the steady paycheck with staff costs covered by the government.

You want to purchase the space that you are renting?  You see it as a good long-term investment?  You need capital to cover your equity in the purchase.   If economic conditions deteriorate, even short term (see pandemic), and you need that capital or financial equity in your space, how do you convert it to cash?  You may have the assets “on the books” but they are not liquid.  On Friday you still need to make payroll and pay your creditors.

I have stressed the significance of cash flow and it is more important than ever now.  You need to be able to forecast your ability to meet payroll and maturing financial obligations timely.

Capital is your savior.