"Simply stated, there are two sides to a business balance sheet," said Vera Muzzillo, CEO of Cleveland-based Proforma. I've asked for a brief explanation of capital, a CliffsNotes version of years' worth of microeconomics training and financial experience, and Vera has obliged by breaking down the numbers in terms I can understand without an MBA. "Assets (capital) on one side and debt and equity on the other side," she continued. "Assets always equal debt plus equity."
It sounds like Business 101, an oversimplification you might find in one of those "______ for Dummies" books aimed at educating the inquisitive layperson on concepts far beyond his or her hope of understanding, and to some extent it is. But this back-to-basics approach can be helpful, especially when dealing with something like capital, a concept so simple it can be broken down into a grade-school-level equation, yet so complex that businesspeople spend years trying to master it—and often fail.
See, of all the reasons businesses fail (and there are plenty of reasons—bad location, down economy, lack of leadership, etc.), insufficient or poorly managed capital is the one that seems to appear on every financial guru's bullet-pointed "Why Businesses Fail" list. It's the second entry on the Small Business Administration's (SBA) reasons for small-business failure, and as such it's likely a major contributor to the alarmingly low success rate of startups (18 percent, according to a Harvard Business School study) and small businesses over the last few years.
In other words: If you want your business to succeed, you better know how to manage capital.
Naturally, Vera is telling me about automobiles. "A simple example would be a car purchase," she said. "If you buy a $30,000 car, put down $5,000 and secure a $25,000 loan, then the balance sheet would look like [this]: $30,000 (assets) = $25,000 (debt) + $5,000 (equity)." This is not a non sequitur, and no, we haven't been sidetracked by a mutual interest in the finer points of mid-sized luxury sedans. The car-buying analogy is a small-scale example of the process by which businesses can increase capital: increasing debt, increasing equity or both.