Chapter 6A

Capital
Management

Chapter 6A
Capital Management

In any business, an entrepreneur

must have knowledge of two financial
objective.
Profitability - is concerned with the
amount of income left over after all
expenses, particularly in relation to
the investment base, which produces
that income.
Liquidity - refers to having sufficient
cash to meet obligations as they are

WHAT
IS
CASH FLOW?

1. What is Cash Flow?

Think in terms of cash, peso signs, flowing in and
out of your business. The sources of cash are
limited.

New equity
Sale of fixed assets
New debt
Sales of goods and services

Why is cash flow is so

important?
For a new entrepreneur to continue
operations, his cash inflow must
exceed the cash outflows. But, if the
cash outflows exceeds the inflows,
the business RUNS OUT OF CASH
and grinds to a halt.

Cash management controlling the cash flow.

Timing and cash flow go

together. You have to match
the timing of cash inflows and
outflows if you are to remain in
operation.

STEPS IN
CASH FLOW
PLANNING

Steps in Cash Flow Planning

Forecast Sales
Identify cash inflows
Identify cash outflows
Determine the net effect when cash
flows in and out.
Determine your cash position over
time.

A controlled cash flow will more than repay the

time and effort you give to it. In fact, it may
save the life of your business and your own
future as well.

Step 1 Forecast Sales

The first and most important
step in cash flow planning is
forecasting your sales revenue.

Step 2 Identify cash inflows

While the sources of cash are new equity and
new debt, they are sporadic-that is, they cannot
be relied upon as permanent or repeat sources.
If your firm sells on a cash basis, your operating
cash inflow will be the same as your total sales.
If you sell on credit, however, your cash inflow
depends very much on the collection of accounts
receivable.
There are factors when projecting collections
the average sales figure for each month.
any expected increase in sales;
the collection pattern-the proportion of billings
for each payments are received in the first,

Step 3 Identify cash outflows

It is easier to estimate wages, taxes,
and insurance with a close degree of
accuracy, but engaging
manufacturing business, estimating
purchases may pose some difficulty.
For an accurate estimate of material
purchases, one needs to study the
sales forecast in conjunction with the
production schedule.

Step 4 Determine the net

effect when cash flows in
and out.
This is done by summarizing the
cash inflows and outflows to
determine their net effect.

Step 5 Determine your cash

position over time.
The entrepreneur simply relates the
cash flow summary to his bank
balance.

3. Definitions of Financial
Terms
I. Capital comprises the total
assets of the business. It is the
total sum invested in the
business. It all includes all of
the funds invested, both owned
and borrowed, plus all accepted
credit.


a. Working Capital these
are the funds required in the
day-to-day operation of the
business.

b. Fixed Capital this is

the part of total capital
that is invested in fixed
assets such as land,
building, machinery,
equipment and textures.

c. Equity Capital the

capital that is furnished
or invested in the
business by ownerentrepreneur is known as
equity capital.

d. Debit Capital
these are funds that
are borrowed or owned
by the start-up
entrepreneur that he
puts into the business.

e. Capital Structure
this term refers to the
total make-up of the
capital of a business
owned by the
entrepreneur.

II. Types Of
Capital
a. SHORT- TERM LOANS this
is commonly defined as
borrowed funds to be paid less
than one year.
b. INTERMEDIATE- TERM LOANSprovide capital of more than five
years
c. LONG- TERM LOANS- have
duration of more than one year
d. EQUITY CAPITAL- Capital (as
stock or surplus earnings) that is
free of debt; especially: capital
received for an interest in the

III. Sources of Capital

The choice of a source of capital
may follow the decisions of what
type of capital to use.

a. Internal Funds-money
obtained from income of the
business is one basic source of
capital that is ignored by many
entrepreneurs. It is not that they
do not think of using internally
generated funds, but that they do

b. Trade Credit - another neglected

source of capital is normal trade credit.
There are several ways in which your
supplier can, in effect, furnish you with
capital. First, the normal credit terms of
30, 60 or 90 days offered by most
suppliers can serve as a capital source.

c. Equity - when you think you need

permanent capital, there are several
places that you can look for equity
capital. First, you should look at yourself.
Do you have any additional funds that
you might invest in your business?

d. Banks everyone knows that

banks lend money, but many
people are unaware of the variety
of services offered by banks.

e. Stand-By Credit is flexible in

the sense that it meets the
financial requirements of
businesses ranging from small to
big.
Standby-credit is extended by
banks to qualified borrowers. It is
ranges from relatively small loans


f. Term Loans - banks also make
loans for fixed periods. These may
be fully drawn advances within
overdraft system-mainly where the
loan is for specific purpose.
g. Leasing is a method of
acquiring business equipment
without capital outlay. Leasing
finance may involve plant
equipment, machinery or vehicle
needs.

h. Commercial bills a further type of

financing done by the bank is
commercial bill. They consist of
promissory notes, generally unsecured,
sold primarily to other business firms or
financial institutions.

i. Personal installment loans - for

moderate amounts, personal installment
loan are available from banks and other
financial institutions. There is no specific
limit on the amount and term of each
loan. Personal loans are made for a wide
range purposes. Personal loans are
repayable by installment.

j. Finance Companies - another source

of funds needed by small entrepreneurs
is provided by financing companies.
While many of their services overlap
with the banks, they will often furnish
capital in cases, which the banks would
reject. Finance company lending also
includes personal loans and mortgage
loans.

k. Leasing - lease finance is expensive

finance. Its real advantage lies in the
conservation of capital and for this it is
invaluable. Leasing should never be
undertaken where there is any doubt

l. Venture Capital
Companies - this form of
investment will involve higher
than normal risk because the
investment will be in small
and/or untried business
ventures and will seldom be
secured against assets such
as land and building.

Problems
in
Obtaining and
Managing
Capital

It is typically hard for aspiring

entrepreneurs to obtain
capital. This is true for two
reasons:
They are usually woefully
ignorant of the need for a sound
capital structure and how to
obtain it.
Lenders are often uninformed or
misinformed about the peculiar
capital needs of the

Problems in Obtaining and Managing

Capital
Inadequate Sales - are caused by
inadequate planning for working capital
requirements.

Heavy Operating Expenses - can also

be a drain on working capital. They can
absorb funds needed to buy inventory,
pay creditors, or finance accounts
receivable. Some entrepreneurs make the
mistake of spending too much on
unneeded expenses and lavish expense
accounts when their weak financial

 Poor Credit and Collection

Policies - lead to large accounts
receivable balances and high bad
debt losses, which also weaken a
firm's working capital position.

Inventory Problems - can cause a

strain on a firm's capital structure,
too. If an owner-entrepreneur
purchases too many inventories or
the wrong mix of inventory or gets
stuck with a lot of valueless old
stock, it weakens his working capital
position.

 Excessive Fixed Assets - can

cause financial problems by
absorbing part of a small firm's
limited funds that could be more
profitably used for working
capital.

5. How to Utilize Capital Properly

Plan your capital requirements

Before you take irrevocable step of committing
your own funds and those you may be able to
borrow, make sure you will have sufficient capital
to carry you through. Be realistic and do not
underestimate your requirements.
You should be able to answer this:
Why do i need this capital?
When do I need it?
Where can I obtain it?
How much do I need?
How long will I need it?
How can I repay it (if it is borrowed)

 Balance Equity Debt

You need to maintain an
appropriate balance
between equity and debt
capital.

Avoid Excessive
Investment
It is usually better and less
dangerous to under-invest in
plant and equipment and

There are several very practical reasons

for keeping down your fixed assets and
capital expenditures.
Too large an investment in fixed capital
may leave too little money for working
capital.
Fixed capital resulting from an
excessive investment in fixed assets
may become burdensome during
periods of declining sales volume or
falling prices.
High fixed cost caused by overinvestment in fixed assets will tend to
make your break-even point too high.

 Balance working capital to sales

To support the level of sales of a new
business, it is important to start with
sufficient working capital. But it is
equally important to maintain an
adequate working capital with respect
to sales throughout the growth periods
of a new firm.

Avoid Excessive Inventories

A business needs to have sufficient
inventory to meet its current needs.
But it can be equally bad to have too
many inventories. Excessive
inventories rob you of working capital

 Study the Capital

Market
Entrepreneurs should
become familiar with the
various types and sources
of capital available and the
ways in which they may be
useful to be able to obtain
capital when you most need
it.

 Get to Know your Banker

Regardless of their current need, or lack of
need, for additional capital, entrepreneurs
should establish and maintain good banking
connections. This is good for two reasons.

In addition to lending money, banks offer

many services that are valuable to the
entrepreneur himself.
If and when a start-up entrepreneur needs
to borrow money, the banker will be able
to give more favorable consideration if he
knows that the entrepreneur is familiar
with his business operation.