Today a company is successful not simply by the results of their business operations but also with correct capital allocation. It’s a process that doesn’t often receive the same level of scrutiny as other business decisions but is just as important. Proper capital allocation is a fundamental part of effective business management.
According to an article in the Wall Street Journal, “How does management decide where to invest capital given the wide array of investment alternatives ranging from mergers and acquisitions to dividends and share repurchase programs, to organic growth opportunities?”
When a company first starts figuring out how to manage its capital allocations it is usually a simple procedure. The vast majority of the earned assets will be reinvested into the growing company. There will probably not be much available for anything else. When a company is successful over a period of time there is usually excess cash and assets to be managed. It must be decided how best to use them to add to the company’s profits..
This requires effective communication between company executives and management. A sufficient amount of information must be gathered and all ideas need to be discussed. Decisions will require being well informed. In today’s business world there is a wide range of business options available.
Capital Allocation Amount
One of the most important decisions a company can make is to figure out the amount of money they want to provide for capital allocation. This can be determined by understanding the comfort level a company has for investment risk. Some companies are comfortable investing more in low risk investments than investments with high risk. Other companies feel they are in a position to attempt riskier investments.
Develop a Process
As a company grows so will their need to develop a process for capital allocation. New investment opportunities are always being offered and research needs to be conducted. Having a process in place can make capital allocation easier and more profitable for any business.