Large corporations utilize capital to provide financial backing for development (growth), to preserve stability, and to manage risks across all areas of their organization. Capital investment decisions determine what a firm may construct, acquire, and maintain in response to shifting economic conditions. From an operational perspective, a capital management system includes; how capital is generated, how it is allocated, and how performance is evaluated over time. This reference provides insight into the key structural components of large businesses, the oversight processes that support capital discipline, and the operating characteristics that promote efficient capital utilization.
1. Identify the Primary Funding Sources and the Rationale Behind Each Source
Most large corporations do not rely solely upon one type of funding source; instead, they will typically combine multiple funding options to strike an optimal balance between cost, flexibility, and risk.
Commonly utilized capital funding sources include:
- Operating cash flows – funds derived from ongoing, day-to-day operations of the business
- Debt – loans, debt securities, revolving credit lines, etc.
- Equity – retained earnings and, for publicly traded companies, equity issuances (i.e., new stock)
- Asset-based financing – leasing, asset-backed lending, etc.
Each funding option will serve a unique purpose. For example, short-term liquidity requirements are typically funded separately from those associated with longer-term capital expansion initiatives.
2. Utilize Capital Allocation Frameworks to Determine Where Capital Will Be Invested
Large corporations will frequently be evaluating numerous investment opportunities within a variety of product lines and geographic locations. Therefore, these companies will utilize standardized evaluation criteria to enable them to make consistent and comparable capital investment decisions.
Examples of common capital allocation frameworks include:
- Return thresholds – minimum required rate of returns for proposed investments
- Risk-adjusted analysis – higher-risk investments will require a greater expected return
- Portfolio balance – a mix of investments intended to grow the firm, maintain its current capacity, and increase the overall efficiency of its operations
- Scenario planning – “best-case,” “base-case,” and “downside” planning scenarios
The utilization of such frameworks helps to limit “politically-driven” capital spending and fosters clarity regarding trade-offs between competing priorities.
3. Govern Capital Investment Decisions Through Committees, Controls, and Reporting
Capital discipline is largely dependent upon strong corporate governance structures. Effective governance systems clearly outline who is authorized to approve capital expenditures and how each decision will be evaluated for effectiveness.
Examples of typical governance mechanisms include:
- Approval levels – capital investment decisions requiring approval at increasingly higher organizational levels
- Investment committees – cross-functional teams charged with reviewing major capital expenditure proposals
- Stage gates – approval to proceed to the next phase of a capital project will only occur once prior milestones have been achieved
- Post-project evaluations – identification of “lessons learned” and accountability for previous capital investment decisions
Effective governance structures allow the organization to remain flexible and adaptable while minimizing the risk of costly capital misallocation decisions.
4. Continuously Manage and Monitor Liquidity and Risk
Large corporations view liquidity as an essential element of their core operating capabilities. These organizations will plan for disruptions to their cash flows, minimize the risk of downgrades to their credit ratings, and ensure that sufficient cash reserves exist should they need to draw upon them in the future.
Examples of critical liquidity and risk management practices include:
- Cash forecasting – routine updates to forecast the availability of cash across various business segments
- Debt maturity planning – managing debt maturities to avoid significant refinancing challenges
- Hedging – reducing the risk associated with interest rates, foreign currency fluctuations, commodity price volatility, etc.
- Stress testing – developing contingency plans to address potential declines in revenues and/or increases in costs
By adopting this approach, large corporations are able to ensure that they have access to sufficient capital throughout both periods of rapid growth and declining economic conditions.
Conclusion
Large corporations structure and manage capital by allocating funding sources, implementing consistent investment criteria, and utilizing robust governance to monitor and manage risk. In addition, liquidity planning, staged approvals, and post-project reviews help to ensure that capital investments are made in a disciplined manner rather than based on impulsive or politically driven decision-making. Ultimately, the most successful organizations recognize that capital is a limited resource regardless of whether there is a surplus of cash. Therefore, successful organizations strive to make fewer, better investment decisions and to ensure that they will continue to have the financial capability to make additional investments during any economic cycle.