Capital Constraint

 

Capital constraint is “net capital available for spending during a designated period of time”. The derivation for the net cash that is to be used for spending purposes is defined as follows (Sussman, 2008, p. 64):

The complete picture of net cash available for capital spending emerges through a capital position analysis that considers all sources and uses of funds, including principal payments, working capital changes, and additions to balance sheet cash reserves, which are added to an income statement-based calculation (Sussman, 2008, p. 64).

The formula for capital constraint that organizations can utilize to determine their level of capital spending ideally is simply the cash flow less contingencies. The cash flow is simply cash sources minus cash uses. The overall formula can be stated thus (Sussman, 2008, p. 65):

(1) Capital constraint = cash flow – contingency

(a) Cash flow = Total cash sources – total cash uses

(b) Total cash sources = debt proceeds + philanthropy + other cash sources

(c) Total cash uses = working capital + principal payments + carry-forward capital + cash reserve requirements + other cash uses (Sussman, 2008, p. 65).

            The capital constraint is a guide to management with regard to what level of capital spending is appropriate, given the company’s underlying financials. The constraint is the upper limit on capital spending. Moreover, the capital constraint guides the way the company makes decisions with regard to capital spending, with all spending being part of a rationalized process, with the constraint and the process for determining the constraint being the overarching guide to making such investment decisions (Sussman, 2008, p. 70).

 

References

Sussman, J. (2008). And now, for the million-dollar question, how much can we afford to spend? Buyer’s Resource Guide. Retrieved 23 May 2009 from http://farihaonline.com/tmp/28096333.pdf

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