Capital management is a mystery to the vast majority of people. While most understand that money flows through global economies, few grasp the intricacies of putting that capital to work for a company. Thus, many struggle to grasp just what capital management is.
Capital Management Defined
Advisory HQ, a top news and ranking organization focused on the business world, defines capital management as “a financial strategy aimed at ensuring maximum efficiency in a company’s cash flow.” Thus, the answer to “what is capital management?” is simply “managing a company’s money.” In reality, though, a more accurate capital management definition is much more complex.
Balance in Capital Management
An accurate capital management definition must include balance. The capital manager’s ultimate goal is maximum efficiency among a number of competing factors. As Advisory HQ puts it, “Sometimes the financial state of a company can be improved by cutting unnecessary expenses; at other times, earnings can be increased by implementing a small change in one of the main areas of business.” Knowing what measures to implement at what times is effective capital management.
Short-Term Capital Management
Capital managers must keep an eye on short-term factors. In this respect, the definition of capital management includes an assets-and-liabilities focus: a company must have enough assets so “the business can easily handle its expenses and debts without any risk to the core.”
For a goods-based business, these assets include raw materials. Managing a company’s raw material assets ensures that all necessary raw materials are present to avoid any production stoppages. Further, manufactured goods should go to market as quickly as possible to collect accounts receivable. This money can settle all accounts payable, and then, finally, any extra revenue creates a cushion for the next cycle.
However, companies rarely pay off all debts before beginning a new cycle, and an entire inventory rarely sells quickly. This is why capital managers must balance various streams of information to determine the best course of action to keep companies from collapsing under their own debt.
Three Basic Strategies
According to eFinance Management, capital management strategies fall into three categories: conservative, aggressive and hedging.
Conservative strategies include “financing the working capital with low risk and low profitability.” In this approach, “apart from the fixed assets and permanent current assets, a part of temporary working capital is also financed by long-term financing sources.” That is, long-term investments, which tend to have lower interest rates and lower profitability, fund part of the current production cycle. A conservative strategy offers the company less immediate reward but more security.
Aggressive strategies favor profitability over safety. Short-term funds, with higher interest rates, fund the costs of the current cycle, and “long-term funds are utilized only to finance fixed assets and a part of the permanent working capital.” As eFinance Management points out, this strategy “saves the interest cost at the cost of high risk.”
Hedge strategies fall somewhere between conservative and aggressive strategies. They are so varied that a tighter definition falls outside the scope of this article. However, those skilled in capital management use a number of procedures to manage risk and return, both long- and short-term.
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