Nov 05, 2021 Mike Midgley

Finance Fundamentals – Managing Capital

Introduction

Next in the Finance Fundamental series is now that we’ve raised and employed capital in your business, the next critical step is managing that capital effectively.

Proper management is essential to ensure that you’re maximizing returns, minimizing risk, and maintaining cash flow. Without a firm grip on your capital, even the best-planned strategy can go awry.

Capital is a non-renewable resource.

It's not like time, which can be lost but recovered; if you waste capital, it's gone. If you waste it on unnecessary expenses or poor investments, you may find yourself in the difficult position of needing to raise more capital, often at higher costs or with more stringent terms.

This is a crucial issue for both you as a business owner and for investors who entrust you with their funds.

Much like a heart monitor for a patient, managing capital requires constant monitoring to ensure everything stays on track.

Below, we’ll explore some key strategies to manage capital effectively, with a particular focus on how SaaS and tech companies can optimize their capital management to fuel sustainable growth.

Systems for Managing Capital

The backbone of managing capital lies in having the right financial infrastructure in place. With the advent of digital accounting systems, even small and growth-focused businesses can now access advanced financial tools that were once only available to larger enterprises.

For SaaS and tech companies, using accounting systems like Xero, QuickBooks, or Sage is crucial for staying on top of cash flow, expenses, and financial reporting.

These tools allow you to automate much of the financial tracking, helping to reduce errors, save time, and make your financial processes more efficient.

A bookkeeper or accountant can help set up these systems and ensure that capital is being used effectively.

More importantly, they can help monitor your capital’s allocation and provide insights into areas that may require adjustment, whether that's shifting funds to R&D, infrastructure, or scaling up your sales and marketing efforts.

Managing Assets and Liabilities

Capital management is not just about tracking cash flow; it also involves understanding and managing assets and liabilities.

Assets, tangible or intangible, such as property, software, and equipment, need to be carefully tracked and managed for depreciation over time.

With SaaS companies, this might mean managing subscription software costs, intellectual property, or even cloud infrastructure.

Managing your liabilities is equally important. This refers to any debts, loans, or outstanding obligations the business has. For instance, if you're using loans to fund product development or sales expansion, you need to manage the repayment schedule to avoid putting unnecessary strain on your working capital.

If your business is relying on external investors, you need to ensure that you're on track to meet the terms of your investment agreements without jeopardizing cash flow.

A balance sheet is an invaluable tool for understanding your business's overall financial health. It will give you a snapshot of your assets and liabilities, which can help you determine the net value of your business and whether you have the right balance between the two.

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Working Capital and Liquidity

Working capital is another key area for capital management, especially for tech companies that experience unpredictable cash flow patterns. For instance, SaaS businesses often have recurring revenue models, which means cash comes in regularly but might take a few days to clear, especially if you're using payment processors like Stripe or PayPal.

It's important to have enough liquidity in the business to cover day-to-day expenses while waiting for those payments to hit your account.

Liquidity management is crucial to ensuring that you can meet your financial obligations on time. If your business relies on invoicing clients, it's vital to have a strategy for managing the time between issuing invoices and receiving payments.

This might mean having cash reserves or an overdraft facility in place to cover short-term gaps in cash flow. Many SaaS companies face this exact issue, especially those in the early stages or those with complex sales cycles.

Even if you are paid upfront, the delay between revenue recognition and cash realization can cause cash flow challenges. Hence, managing your working capital is an essential part of sustaining and growing your business.

Cash Reserves

Cash reserves are another critical element of capital management. Many entrepreneurs make the mistake of thinking that a healthy bank balance equates to business success.

While it's tempting to dip into reserves for new opportunities, purchases, or unnecessary expansions, it's vital to maintain a buffer to protect your employed capital and business in case of unexpected downturns.

If you're fortunate enough to have cash reserves, consider how best to manage them. Instead of letting your reserves sit in a low-interest business account, you could consider moving them to a high-yield savings account or short-term investments that can provide higher returns without taking on too much risk.

For SaaS businesses, having sufficient cash reserves can be crucial for navigating long sales cycles, product development stages, or marketing pushes. It's essential to have enough liquidity to continue operations without constantly relying on external funding.

Profit and Loss Management

Once you have a solid handle on your working capital and cash flow, you need to continuously assess your profit and loss (P&L) statement.

The P&L provides a clear picture of how much money is coming in, where it’s going, and whether your business is operating profitably.

For SaaS businesses, understanding your gross margin is especially important, as it can fluctuate depending on customer acquisition costs (CAC), the lifetime value of the customer (LTV), and product development costs.

By analyzing your P&L regularly, you can spot trends and inefficiencies, such as rising CAC or underperforming channels, that could be dragging down profitability.

A key performance indicator (KPI) for SaaS businesses should be Gross Margin and Operating Profit. High gross margins are typical for SaaS businesses due to the nature of the recurring revenue model, but they can be eroded by high customer churn, over-investment in sales ad acquisition costs, or scaling issues.

Conclusion

Managing capital effectively is about ensuring that your business is always in a position to make the most of the funds it has available, plus provide the distribution returns stakeholders and investors require.

From cash reserves and managing assets and liabilities to keeping a firm grip on working capital, every aspect of capital management needs to be handled with care.

For SaaS and tech companies, it's especially important to continually reassess how capital is being used, monitor cash flow, and make sure that each investment is contributing to the long-term growth and profitability of the business.

The last thing you want is to squander your capital by failing to track how it’s being spent or mismanaging your financial systems.

View MoreFinance Fundamentals Articles: 

Finance Fundamentals - 101SQ
Finance Fundamentals - Raising CapitalSQ Finance Fundamentals - Employing CapitalSQ Finance Fundamentals - Distributing CapitalSQ

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Published by Mike Midgley November 5, 2021