Why is financing so critical? Finance is the ‘oil’ that your business ‘engine’ uses to run efficiently and effectively. Ensuring that your business is ‘well-oiled’ should, therefore, be one of your prime considerations, as too little oil will cause your business engine to stall in the short to medium term, while excess oil is costly, and will impact your business in the medium to long-term.
Throughout your company’s business life cycle, there will be various milestones which will trigger the need for financing. These will include the initial, or start-up phase of your business, which will require so-called ‘seed-financing’. On a more regular basis, you will need to ensure sustainable working capital to operate efficiently, apart from the need to finance capital expenditure or assets. In the medium to long-term, you will need to invest in research and development, as well as in rolling out new projects.
A realistic and well-considered business plan can be an important starting point to this process. This plan should include an outline of your strategy, as well as how you will conduct your operations, manage your HR requirements and your marketing activities. Your business plan should also outline your capital expenditure requirements, and in parallel be translated into a financial plan, with cash flow projections that will determine the financing and cash required to run the business.
After you have developed a cash flow analysis and determined when your business will make a profit, you might realise that for your business to grow and thrive you may need to source financing apart from access to your retained profits, personal savings, or loans from friends or family.
Borrowing money is one of the most common sources of funding for a small business, but obtaining a loan isn't always easy. Before you seek financial assistance, you should thoroughly assess your current financial situation.
Ask yourself the following questions to determine your business' financing needs:
- Do you need more capital or can you manage the existing cash flow?
- What is the nature of your need?
- Do you need money to start or expand your business, or as a cushion against risk?
- How urgent is your need?
Whenever possible, it's better to anticipate your needs rather than looking for money under pressure. You also need to evaluate the extent of your risk. All businesses carry risk, and the degree of risk will affect both the cost of your loan and available financing alternatives. Moreover, financing needs are generally more critical during transitional stages - start-up and expansion being two of the most urgent and costly. Other considerations will include the state of the industry you operate in, and whether your business seasonal or cyclical in nature.
There are two main types of financing:
- Equity financing, and
- Debt financing.
Equity financing (or equity capital) is money raised by a company in exchange for a share of ownership in the business. Equity financing allows a business to obtain funds without incurring debt, or without having to repay a specific amount of money at a particular time.
Debt financing means borrowing money that must be repaid over a period of time, usually with interest. Debt financing can be either short-term, with full repayment due in less than one year, or long-term, with repayment due over a period greater than one year. The lender does not gain an ownership interest in the business, and debt obligations are typically limited to repaying the loan with interest.
Finally, the critical nature of business financing means that as a business owner, you need to be aware of common pitfalls and errors made in this area.
Take the time to understand well your company’s financial requirements, and to monitor the financial health of your business. It is vital to refer to professional advice throughout this process, particularly when it comes to evaluating financing options. Establish a strong working relationship with the providers of your business finance, primarily through regular and open communication. The management of your business working capital should always be at the top of your priorities; and be aware of the risk of under-capitalization - the lack of ‘oil’ for the business ‘engine’ we mentioned above - which is a number one killer of start-up businesses, and can be fatal to the future growth of your company.