Capital Adequacy: What is it? Why should I care?

Remember: I'm a banker. Capital adequacy refers to whether the structure of the financing used by individual financial institutions is sufficient to preserve the safety and soundness of the financial system. Typically, banks are expected to maintain $1 of capital for every $8-$12 of assets.

The latest statistics from the Small Business Administration (SBA) show that "two-thirds of new employer establishments survive at least two years, and 44 percent survive at least four years." This is a far cry from the previous long-held belief that 50 percent of businesses fail in the first year and 95 percent fail within five years.

A common fatal mistake for many failed businesses is having insufficient operating funds. Business owners underestimate how much money is needed and they are forced to close before they even have had a fair chance to succeed. They also may have an unrealistic expectation of incoming revenues from sales.

It is imperative to ascertain how much money your business will require: not only the costs of starting, but the costs of staying in business. It is important to take into consideration that many businesses take a year or two to get going. This means you will need enough funds to cover all costs until sales can eventually pay for these costs.

Some of that can be money that you borrow, but some should be money you invest in your business. Generally, to attract bank financing, the bank likes to see about $1 of capital for every $3-$5 in debt. Asset based lenders are comfortable with $1 of capital for every $5-$10 in debt because their loans are more based on the value of the accounts receivable. Beyond that, equity capital should be considered.

Take a lesson from the investment banking/banking industry: Sometimes there is such a thing as too much leverage.