Is Your Pool of Capital Sufficient? (September 2014)

Several months ago I wrote What Can You Learn from a Waterfall? and referred to the pool of water at the bottom being analogous to the pool of capital that a business accumulates from its retained earnings.

Recently, I have talked to business owners who have an abundant pool of capital in their business as well as those who have a depleted pool of capital. The biggest difference that I notice in those two groups is that the business owners who have an abundant pool of capital are much less stressed than those who have a depleted pool of capital.

This isn’t necessarily because the businesses with adequate capital have earned more over time, although that may be the case.   Rather, it tends to be the case that some business owners have decided to pull as much capital as possible out of the business while others have decided to allow the business to dictate how much capital is available for distribution. That’s an important distinction.

Owners who have pulled out too much from their business are often stressed about things that other business owners take in stride and recognize as the ebb and flow of the cash flow cycle. Rather than saying “use the line of credit, that’s what it’s there for” when receivables grow, businesses with insufficient capital pools are scurrying to pull in receivables and delay vendor payments. Their line of credit is already stretched and has no slack capacity. This leads to an inordinate amount of time and dollars wasted.

Businesses with an adequate capital pool generally have easy access to bank lines of credit for working capital. The owners recognize that they have a great deal invested in their business and act accordingly. They have lending ratios that are in line with bank credit committee norms.

Businesses who do not maintain a healthy capital base will find it difficult to access capital in both good times and bad. In good times, they may not have a healthy enough borrowing base to support receivables financing from traditional banking sources and may have to look toward alternative and more expensive sources of capital. When times get tough, they will find that they have few choices.

What is the right amount of capital?   That depends on the businesses size, its industry, earnings track record and a number of other factors. But if you find that it is difficult to access capital, then start by looking inward as opposed to blaming the banks and capital markets.

If your business could benefit from fractional CFO services, I would welcome the chance to speak with you. Please give me a call at (314) 863-6637 or send an email to [email protected].

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