Proper capital planning helps predict funding needs and serves as a very valuable tool for determining how much financial support is needed and when. Additionally, it allows more time to explore all possible financing sources and to negotiate under more favorable conditions.
Before requesting any financing it is key for each company to plan its capital needs ahead of time. According to the publication “SMEs in Latin America and the Caribbean: A strategic business for banks in the region" by the Inter-American Investment Corporation it is advisable not to assume debt in the middle of a crisis. Frequently in these cases, unforeseen loss of suppliers’ credit, the impossibility of paying salaries or other emergencies may occur compelling to rapidly take out loans under the most unfavorable conditions.
According to information published on the website Emprende PYME, “capital planning consists of a complete review of the balance sheet to help analyze cash flow, assets and liabilities.” Additionally, it is advisable to prepare a pro-forma financial statement, which is a projected balance sheet for the next 1 to 3 years.
It is also important to prepare an itemized budget including: sales, production (to obtain the cost), direct salaries, indirect expenses and administration costs.
List of Priorities
When interest rates are low and money is cheap, a businessman might be tempted to take out loans to purchase equipment or to make other capital good purchases. If this is the case, the SME must be sure that this decision is based on real needs. The Inter-American Investment Corporation affirms that “the possibility of a hike in interest rates should not be a valid reason to spend money in things that one does not really need.”
For example, if the company needs to increase its production capacity through additional equipment. However, purchasing equipment because it may be more expensive to do so tomorrow is not sufficient justification. This may lead to purchasing a machine that is not really needed (surplus in production capacity) and debts that will have to be paid in the future.