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How to Manage Capital Effectively?

Updated on 2013-05-20 by Guest







Capital proves to be lifeblood of every business, which keeps various departments and functions of the organization moving and growing. Without capital, decision making and implementation becomes impossible. Capital thus becomes the major driver for a business to survive and grow fast under the competitive pressure. Further availability of sufficient capital is mandatory for a business to look ahead to the road of market leadership. This increasing importance of capital as the source for every successive growth of business makes it essential to understand and implement effective steps for management of capital.

In addition to ensuring the survival and success of business, effective capital management proves important for the shareholders as well. Effective capital management would lead to higher rate of return on the long term investments made by the business. When the rate of return on capital is more than the cost of capital, it would lead to an increase in the market value of the business and hence the value of investment to the shareholders would also increase. Thus managing capital effectively is observed to have a direct link with the basic objective of financial management – maximizing shareholder value.

Effective management of capital involves four major steps as follows:

1. Preservation of capital
2. Optimization of the use of capital
3. Raising capital from optimal sources
4. Investment of capital to earn returns

An in depth understanding on each of the steps to manage capital effectively would go a long way in ensuring the success of business.


1. Preservation of capital
      Preserving and maintaining the capital is the first and basic step in capital management. So for any business to succeed, it should always keep a watch on the important financial statements such as balance sheet, profit and loss statement and cash flows to analyze and understand how the capital is performing. You should make a thorough analysis of the environment to understand how the market is performing, what are the competitor’s strategies, whether there are any new market opportunities to be tapped etc. Further the business should also take care to understand the cash flow requirements of the company. You should always be on the watch out to ensure that adequate cash is available to meet the operational requirements and should continuously work with your value chain partners to maintain effective liquidity of the business. On the other hand, the debt repayments of the company should also be frequently reviewed to tap any new opportunities for renegotiation so that the cost of debt is reduced. Also the business should take steps to cut down the costs wherever possible without any erosion in the value of the business.


2. Optimization of the use of capital
Businesses on the lookout to grow fast and above its competitors should always have the ability to make optimal use of the precious capital. An active and efficient approach to management of assets in the business would ensure that capital allocation to various assets is made effectively. You should keep a close watch on the deployment of capital to ensure that capital moves to its suitable use and that it is preserved and allotted effectively. Further allocation of capital should be done after systematic research on all alternative strategies and after benchmarking the asset allocation with that of the competitors in the industry. This would take care to ensure that capital moves to its effective use and thereby enables market leadership with respect to optimization and value creation through the use of capital.


3. Raising capital from proper sources

Companies which frequently tap new market opportunities would have a continuous need to raise capital to meet their expansion needs. In such situations, you should make a detailed analysis on the alternative sources of capital and should also try to get a deep understanding on what the debt providers or the market investors expect from your business’ statements. Even though the balance sheets would possess strong ratios, acquisition of capital might sometimes be hindered by various reasons such as external shocks in the market, recession in the economy and such other causes. The onus thus lies on the business to look out for optimal sources and best times to raise capital. You should have a better understanding on various investment alternatives so that you could choose the best source of capital which has the least cost and best suitable use to the company. Further there are many other capital sources beyond the traditional forms of debt and equity - one such alternative would be venture capital investors. It thereby becomes essential that you search the market thoroughly to find a capital source which best suits your business.


4. Investment of capital to earn returns

The final and the most important step in managing capital effectively is to find the best way of investing the capital so as to ensure that it earns a rate of return that is higher than the cost of capital acquired. You should be on the hunt for best investment opportunities and tap them effectively as you find so that your capital earns best returns. The increasing complexity of the investment world demands rigorous research to find better investment options, but it proves to be highly valuable to ensure effective capital management. You should always try to tap better investment options for your capital rather than pushing your capital for the same old source of use. This would ensure that your capital moves to its optimal use and earns more than its cost.


Further to manage capital effectively is to ensure that the following points are kept in mind while making any capital decisions:

●      The cost of capital is sustainable throughout the duration of the project
●      The financing options available in the investment world are thoroughly analyzed
●       The business is in a good position to refinance debt whenever necessary
●       The investment decisions are best aligned with the business strategy
●       The capital allocation across the business is made to ensure the optimum use of capital and higher rate of returns on the capital









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Trading financial instruments, including foreign exchange on margin, carries a high level of risk and is not suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in financial instruments or foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with trading and seek advice from an independent financial advisor if you have any doubts.