Module 1: Financial Management
While most small businesses are started with personal savings, loans from friends and family and – heaven forbid, credit cards – there will come a time when you may need additional funding from a lender.
Before we cover this in more detail, let’s review a few terms you may not be familiar with. These are terms used in business financing, so you should understand what they mean for you and your business.
- Equity financing: These are the funds that are invested in your business, and they stay with your business. This could be the savings you initially put into the business or other funds you raised. These are usually a permanent part of your business. For larger businesses, venture capital can also be part of their equity financing.
- Debt financing: These are the funds that you borrow and that need to be paid back. This usually requires you to put some money into the equation, and you need to pay the funds back with interest, which, of course, further increases your debt.
- Working capital: This is the money that you use to cover the cost of your daily operations in the short term. This would include expenses related to inventory and overhead.
- Fixed asset financing: This is the money you use to purchase equipment, vehicles and real estate; things that have tangible value and can often be used as collateral.
Helpful tips on business financing
- You need to spend your own money. Before any lender will invest in your business, you need to put money into it. A bank or a lender will never give you 100% of the funds you need. They want to see that you are willing to share the risk. This doesn’t necessarily mean dollar for dollar either. Some collateral can be considered cash, though you should never put your house up as collateral on a business loan.
- The right to borrow is earned. Lenders run a business. They make loans to you so that they can make money through interest and other methods of leveraging the money in play. Borrowing money is a privilege, and to get the best deal possible, you need to demonstrate that you can manage money and debt and run a profitable business.
- Show profitability. Profits are what lenders and investors want to see. This is what your financial statements are designed to show. They will demonstrate a pattern of profitability and the ability to manage and maintain a positive cash flow.
- Understand the power of working capital. Experienced business owners know that working capital is critical. The amount of working capital flowing through your business allows you to grow and expand without having to finance short-term loans.
- Be lean on fixed assets. Fixed assets consume working capital because you need to make sizeable down payments and service loan repayments. If possible, consider purchasing used equipment or leasing equipment instead of buying it outright.
- Match sources with uses of funds. Fixed assets should be financed with long-term loans that mirror the asset’s lifecycle. You don’t want to keep making payments on a piece of equipment that was obsolete five years ago or sits unused in the corner of a warehouse. For example, current assets (accounts receivable and inventory) should be financed with current liabilities, such as lines of credit or credit cards. New business owners often make the mistake of buying a fixed asset with short-term debt. But that means you pay for the asset faster than it can generate profits to cover the loan repayment.
- Understand your financial statements. Yes, we’re back to financial statements. You want to learn to use your balance sheet, cash flow projections and balance sheet to keep track of your business’s performance and profitability and be able to use these tools in discussions with lenders. You need to be able to answer their questions about your operations if you want to secure a line of credit or a loan.
- Leverage your collateral with care. Your lender may ask you about collateral for a loan. Collateral is the tangible assets (machinery, equipment, real estate, vehicles, etc.) you have on hand to guarantee that the loan can be repaid. Inventory the collateral you have available, as well as the risks of using it to secure financing.
- Speaking of risk. Every loan has different types of risks and costs. For example, a credit card is easy to use, but the interest rates can kill you. Take the time to read the fine print of any loan or credit arrangement and understand the total risk you are taking on.
- Keep your private and business finances separate. This includes your personal and business bank accounts, loans, records and assets such as computers, phones and printers. If you need to move money between accounts, do it online, so there is a record of the transaction.
- If something doesn’t make sense, ask. Running a business requires you to continually update your skills, knowledge and abilities. There are plenty of resources to guide you, including the Small Business Administration and this website.