There are many tasks every small business owner must handle personally, but none calls for personal attention more than allocating capital. Cash management is also a critical task, but operating cash is not capital. Cash pays expenses and is evaluated daily, weekly and monthly, while capital pays for investments in the future of your business and is evaluated over years—possibly even generations.
Accountants classify capital expenditures according to these three categories:
1. Replacement and upgrade: This category differs from repairs, which are funded by operating cash flow. Reserve this type of capital for bigger commitments, such as when equipment becomes outdated or repair is no longer an option.
2. Innovation: Exciting innovations in digital devices and applications create opportunity—and cause disruption. Small businesses need to delegate precious capital for innovation in a way that maximizes opportunity and minimizes the cost of disruption.
3. Growth opportunity: Perhaps you’re thinking about expanding your market footprint with an acquisition or new branch. Maybe it’s time to build more online capability. Or you might invest in a new product direction or a digital inventory management system connected to the supply chain.
Decisions about what to invest capital in—and when to do it—vary by business. But all small businesses need to ensure they're spend capital properly.
Here are three best practices when it comes to allocation:
1. Don’t use operating cash to pay for business assets that have a long life span (more than one year).
2. Leave profits in the business to produce retained earnings that can used as reserves for capital investment.
3. Augment retained earnings through a bank loan when the timeline of an opportunity or unfortunate capital-eating event doesn’t match your internal funding ability. Having retained earnings can make it easier to obtain a loan–bankers love it when you have “skin in the game.”
As we move from economic recovery to expansion, you will likely make more decisions associated with growth opportunities. Designing a capital plan that combines proper allocation of cash, retained earnings and banking resources will go a long way toward helping you stay relevant to customers, maintain a competitive advantage and make more profits.
To a small business, the only thing more precious than cash is capital. Use it wisely.