Capital allocation is the process of distributing a company’s financial resources to enhance the firm’s long-term financial stability and value creation. It is about where and how a corporation decides to spend the money that the company has earned. Capital Allocation is important because it helps to improve a company’s overall financial position. For Jason Kwan and the Pearl West Group, Capital Allocation has been key in determining which direction the Amazon mergers and acquisition firm will take.
The Importance of Capital Allocation
Kwan states that he is proud of his company’s strategy because it has made them into great capital allocators. “We understand the power of compounding our capital and the importance of achieving a great return on invested capital. When we run our businesses, we make sure we’re not spending 1 dollar and getting only 50 cents back.”
Capital Misallocation Can Have Negative Impact
As capital allocation drives success and financial improvement, capital misallocation can have the opposite effect. It is essential that companies who are seeking to make decisions on how to spend and allocate resources pay attention to important metrics and drivers before finalizing plans. “We believe that capital misallocation is terrible for the company because we’ll have fewer profits to reinvest,” shared Kwan.
Achieving Growth, Not Just Profitability
When it comes to capital allocation Kwan highlights that companies must understand that not all growth is profitable. Some may wonder why a company would pursue an opportunity if it weren’t profitable. However, it is important to understand that while profitability is critical to a company’s existence, growth is crucial to long-term survival.”It seems like a rapidly growing company is what everyone wants, but if you’re doing something wrong, more is not what you want,” advised Kwan.
If a company achieves profitability, but the capital allocation strategy does not foster growth and development, this can diminish the company’s long-term survival. “The metric ROIC (Return on Invested Capital) can serve as a gauge that tells if you’re doing something correctly. The magic of compounding can work wonders if you can get your company running at a high ROIC and the ability to reinvest profits back into this compounding machine. We’re continuously striving to achieve a capital compounding machine that can churn out excellent quality brands at scale.”
While Kwan says they aim for increased revenue and profitability, they have decided to take a slow and steady approach as they perfect their processes. “We’ve raised no external capital so far. However, a downside to not raising capital is that we’re not growing as fast. We didn’t feel an urgency to do it because we wanted to perfect our systems and show an excellent track record before raising external capital.” This means that when they are ready to take on shareholders, the company will be better positioned to make capital allocation decisions that will increase shareholder equity.
Like every entrepreneur should be, Kwan states that he is “proud of the team we have at Pearl West Group. We started this several years ago when we had no idea what we were doing, but we managed to find the right mentors, the right people who helped guide us to where we are now. None of us came from an investment banking background, but we’re entrepreneurs at heart, and we were able to figure things out with the resources we have.”