Structuring your Business Capital

Whether you are trying to survive or scaling like crazy, managing capital in your business is a job that will never go away. How much to keep in the business as cushion versus reinvesting or distributing it can be a tough call. We often recommend breaking up your capital into four categories to simplify your financial planning:

Operating: Operating capital is crucial to the daily operations of any business. It helps us manage our expenses and ensures that we have the resources we need to run our activities without any financial hiccups. To maintain stability, it's prudent to keep approximately two months' worth of overhead expenses in this category. These expenses include labor, marketing, facilities costs, payroll taxes and benefits, and all other operational expenditures like office supplies and insurance.

Replacement: As a responsible business owner, it's important to plan for the future and anticipate the wear and tear that comes with owning physical assets like computers and office furniture. Let's say you bought five computers for $1,000 each, and they are expected to last for five years. By allocating $1,000 a year towards replacing them, you can ensure that you have the funds ready when the time comes to get new ones. This way, you can avoid any unexpected expenses and continue operating efficiently without any disruptions.

Investment: This capital is earmarked for pursuing opportunities that will help us expand our business, onboard new talent, or acquire new facilities, and should be allocated judiciously in alignment with our long-term strategic goals. Considering whether to bring on a new LSP? Set aside a month's salary for the new hire before actually bringing them on board. By doing so, you can get a better sense of how this expense will impact your cash flow, and ensure that you have the resources you need to support the new hire and maintain your operation plus gives you an idea of their profitability when you do hire them.

Beyond the three categories of capital, any excess funds can be allocated to personal capital. This clear delineation of funds not only supports our financial planning but also aids in evaluating our financial performance more accurately. A key performance metric to focus on is the Return on Invested Capital (ROIC), which is derived by dividing our net income by the invested capital (the sum of operating, replacement, and strategic growth capitals). An increasing ROIC year-over-year is indicative of our efficiency in utilizing capital to generate profits. By tracking this metric and ensuring that our capital is allocated effectively, we can continue to grow and thrive as a business.