Back to basics: Finance 101

The world has changed. With the economic slowdown and the worst global recession in generations, it’s easy to get caught up in the hype. The good news is that this market disruption usually presents great opportunities to reposition your business for the upturn. As a small business owner, now is the time to get back to the basics of financing your business.

In business, the old saying “cash is king” is more relevant than ever. It’s important you have a clear financing strategy in place to reach your goals. Whether it’s purchasing equipment to grow your business, securing a loan for fixed assets or preparing to buy another business, you may require financing to get your plans across the line. There are many options to consider as you embark on developing a financing strategy.

Human capital
You hear fabled stories of great companies being built with little or no capital.  Michael Dell built his personal computing company in college with less than US$1,000. If you have a great idea, a comprehensive business plan and strong attention to detail you may realise your business doesn’t need much capital at all.

Brokers are a great example of a business that requires little capital. The downside is that businesses that succeed with no capital require a lot of time and effort.  As a result, the cost of the business is not in its interest payments or fees, but rather the time and effort required to develop, market and administer it. If you have the energy, mind, time and focus, utilising your own human capital can be the most cost efficient way.

Fund it yourself
The easiest type of capital for a small business is your own private capital. Nine out of 10 businesses are started this way, either in the form of home equity or personal credit cards. The main advantage is the ability to access credit quickly without the need to develop a detailed and convincing business plan for a bank or investor. The disadvantage is that private capital is finite and puts your personal credit on the line against the success of your business.

FF capital (friends and family)
Borrowing money from family and friends can be a great source of capital as these are the people who support your vision, ambition and business goals. However, beware what you save on funding and interest payments you may pay for in emotional costs. It’s advisable you be as transparent as possible on the terms you construct with your family and friends to ensure the cost of capital is not more than you bargain for.

Suppliers and vendors
Suppliers and vendors can be a great source of capital and cashflow. Account payable management is an untapped source of cashflow for many small businesses. In these times, managing your cash is so important that even extending payments can help your business. Working with vendors for ‘trade credit’ by developing a payment plan can relieve stress on your cashflow while maintaining your sales. A net 30 or 60-day payment plan can be secured if you have longstanding relationships with your vendors.

Angel Investors
If you’re fortunate enough to have a rich relative or know of affluent individuals who are willing to support your business, then you’re in luck. These are angel investors. Unlike venture capitalists, they invest their own capital in your business in return for a share of equity or convertible debt. Angel investors are somewhere between the friends and family capital and venture capital, and mainly look at investments below $2million. The downside here is that for the high level of risk angel investors take on your business, they will require a high level of return over a defined time period, usually around five-to-seven years. The other downside is this type of funding can be expensive compared to bank financing, since you’re giving up a portion of your company.

Venture capital or private equity
Venture capitalists or private equity firms can be another great source of capital.  It’s important to keep in mind that these firms are in the business of investing capital in companies to gain a decent return for their investment over a specific time period. The advantages are that there are no interest payments or monthly payment terms to be concerned with. In addition, these firms may come with special skills, connections or expertise that can be great assets to grow your company. However, keep in mind you’re giving away part ownership, which also gives away a portion of the revenue and profits.

Business loans/business banking
Banks are a great source of funding and provide several different products to fit your needs. Make sure you’re aware of all the contractual funding costs including interest, fees and penalties when securing credit cards, overdraft facilities or business loans. Also, make sure you have accounted for these costs in your overall business plan. Before you approach your bank, there are a couple of things to consider to improve your chances of securing the best terms and rates.

Character
Maintain a clean personal credit profile to avoid difficulties in accessing credit.  Banks use an individual’s management of personal credit to assess how they  might manage their business finances. Sacrificing your personal finances for your business finances is a major risk you do not want to take.

Capacity
How will you repay the loan? Establishing a good deposit or transaction history with your bank to demonstrate strong cashflow, helps provide a strong case for the business’ ability to service a loan.

Capital
What do you have invested in your business? Demonstrating that you have some of your own capital at stake in conjunction with a solid business plan, will give the bank confidence that you have just as much to lose or gain on the venture as it does.

Collateral
What forms of repayment can you make? For larger loans, showing hard assets such as inventories, accounts receivable, equipment or buildings will help support your finance request.

Conditions
How will the money be used and under what circumstances? Is the use of the capital logical, reasonable and prudent? It is important you clearly present the use of the funding and its expected return or how it will grow your business.

The world is changing and presents lots of opportunities for small businesses. Ensuring you have the right financing strategy for your business will determine whether you can capitalise on the next big opportunity.

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