Originally posted on Forbes
Effectively leveraging capital is one of the most important—and potentially difficult—decisions for business owners and leaders. While many businesses may have long wish lists, it’s important to carefully target investments that can bring real ROI—as well as to decide if now is even the right time for expenditure of any kind.
Below, 16 experts from share important factors owners and leadership teams need to remember when considering deploying capital for their organizations.
Members of Forbes Finance Council share factors to consider when deploying capital for your business.
1. Refer to your business plan.
Having capital can prove a distraction for many business owners. Before making any decisions, refer back to your business plan and strategy. What did you believe were key areas of investment before you had any capital to deploy? That is what you should stick to now. Don’t let your compass be influenced by the amount of capital you have. -,
2. Pay attention to the payback period and ROI.
It is critical that the outlay of funds aligns with your five-year business plan, with special emphasis around the period of payback and ROI. Several factors should be considered, but particular scrutiny should be applied to the assumptions used for the demand of products that will consume the new supply as well as the availability of the asset being considered, including best-case and worst-case scenarios. Assigning ownership is key. -,
3. Know what you expect in return.
The one important principle is a solid underlying business case to support the deployment of capital. What is your business expecting in return? Might there be more attractive options or priorities? Capital is limited; use it wisely! -,
4. Make sure you understand the cost of capital.
Deploying capital needs to circle around the important principle of building shareholder value while maintaining sustainable operations. The fine balance between pursuing growth and ensuring the sustainable operational cost base is hinged on an understanding of the true cost of capital. CEOs need to really understand their cost of capital before embarking on capital-intensive projects. -,
5. Maintain a long-term perspective.
Amid the current pandemic, a conservative approach is more important than ever because it provides business owners with flexibility and the ability to adjust to the unknown when times get tough. It’s imperative to deploy capital from a long-term perspective if your goal is to create lasting value for your business and assets, and leverage needs to be applied in a way that supports that perspective. -,
6. Remember opportunity cost.
When making a decision on how to deploy capital, one should always remember the concept of opportunity cost. All the potential uses of capital can be viewed as an opportunity cost for every other use. This forms a basis of comparison and initial assessment among all options when deciding on the optimal capital allocation plan to achieve maximum net present value. -,
7. Review your business timeline.
Timing is key. Before making a decision, make sure to review your business timeline and target metrics. Simply ask yourself, “How much capital do I need to get to my next major milestone?” Find out the amount and decide when would be the perfect time to secure that capital. That way, you don’t make the mistake of over-leveraging or under-leveraging the capital your business needs. -,
8. Look for the low-hanging fruit.
Start by deploying capital in areas of your business where you know it is going to have significant ROI. Add that new service or launch that product feature—there is low-hanging fruit in every business. It’s your job to find these opportunities by talking to customers. Each time you efficiently deploy capital you open up opportunities to take bigger and bigger bets within your business. -,
9. Solidify your foundation first.
The most important principle to remember is to prioritize your needs. A common mistake is deploying capital in areas that align with “big dream” ideas before using it to solidify a foundation. Instead of big offices and company cars, pay down debt, build up inventory and invest in human capital. It might not be the fancy choice, but establishing a solid foundation is always the right choice. -,
10. Always check your cash flow.
Evaluate risk versus reward when making these decisions, and always check your cash flow. Maybe you have an extra $20,000 that you could use to build your business, but it will take three years to earn it back. Evaluating this against your cash flow and on a timeline puts the decision into perspective and takes out the associated emotional elements. -,
11. Get a grasp of your business’ strength.
Understanding your business’ strengths, weaknesses and margins will help you effectively leverage and borrow capital. Capital should only be leveraged or borrowed with a plan in place that could result in a positive return on investment. Projections and keeping a close eye on your business cash flow will give you a good idea of how much debt you service. -,
12. Identify where value is being created.
Critically reviewing your spend areas, identifying where value is being created and defining the return of a dollar invested is crucial to understanding where in the value chain to invest your resources—not only in capital but also in focus and time. This will drive you to ask the right questions internally and strategize around the high-value creation areas throughout your business. -,
13. Continue to replicate proven methods and results.
Organic reach and investments should always be a priority. If you have an effective marketing campaign that adapts to today’s digital world and you are constantly innovating, then continue to replicate your proven methods and results. Do not make a decision on deploying capital because you hear others doing so; always focus on the organic and if deploying is needed, look for lower-risk investments. -,
14. Prioritize risk mitigation over maximized gains.
Leveraging other assets is an essential component to maximizing the potential of your business and money. However, security is the cornerstone of building long-lasting wealth and achieving the true phenomenon of compounding. When leveraging, risk mitigation should have a higher priority than maximized gains. Slow, steady and secure is the true path to optimization and sustainable profitability. -,
15. Avoid going into debt too soon.
The basic building blocks of the capital structure are equity and debt, each playing its role. I wouldn’t recommend opting for debt until the business or at least some parts of the business are stable, you’ve identified a repeatable revenue model, and there are metrics to give comfort that the company will be able to service its obligation with a margin of safety. -,
16. Break it down into smaller investments.
Most major capital deployment decisions can be decomposed into staggered data-driven mini-decisions. Always look to buy the “cheapest” mini-decisions first. -,
