Business finance is the management of money and other assets in a business. Financing is the act of bringing money into a business for the purpose of expanding operations, or purchasing new assets.
Entrepreneurs need to fully understand the principles of financing in order to keep their businesses profitable. These principles include accounting methodologies, investment strategies, debt management and etc.
The importance of business finance
Money is essential to start, run, and grow any business. Even maintaining your business’s competitive edge and customer base will require some investments to be made over time.
Without proper financial management, your business would fail to meet its short-term and long-term goals, and may lead to bankruptcy.
Equity investments can be obtained through a number of ways. The best option for startups is to obtain investments from venture capitalists and angel investors since you will have access to expert guidance for any issue your business may face in the future.
But if your business has been around for a long time, you may be better off selling shares of stock to the public. That way you could obtain a large sum of debt-free capital, at the expense of loosing a considerable percentage of ownership in your business.
Each method has its own set of advantages and disadvantages. You may also want to obtain insurance for accidents, liabilities and business vehicles as a counter measure for sudden risks that may take place at times of financial hardships.
In order to reach your business’s vision, you will need to prioritize the use of your financial resources. Your short-term objectives have the ability to manipulate how money is spent so, act wisely.
If you had taken any loans, then repaying the principal amount along with the interest on time should be one of your goals. If investors are involved, giving them the best possible returns within the agreed time-frame should be your priority.
Main reasons for a business to be in need of finance
To start a business
It’s impossible to start a business without money. Even online businesses require some amount of working capital to purchase the domain and web hosting.
Depending on the type of business you are starting, you may have to purchase office space, office equipment, production machinery, and company vehicles. You will need money to pay employee salaries as well.
It will take at least six months before your new business starts to generate enough profit to cover all these expenses. Therefore, securing money from sources of finance is the best option.
To cover short-term expenses
If you don’t have enough finances to cover short-term expenses such as payroll, rent, utility, and debt, your business operations will come to a halt.
If you don’t pay salaries on time, employees will start to question the stability of their workplace.
Creditors may knock on your office door anytime demanding the money you owe. Failing to return their money on time will damage valuable business relations and the reputation of your business.
To counter such issues, you must rely on your short-term finance sources such as business lines of credit and invoice financing.
You can use your business credit card as a line of credit to cover any short-term expenses. Invoice financing on the hand, allows you to take money in advance for an outstanding invoice.
Also, you could try reducing the discounts given until you are financially stable.
To cover long-term expenses
You can’t rely on short-term finances for your long-term expenses. Doing so will adversely affect your short-term expenses.
Long-term expenses include buying new machinery, vehicles, offices and etc, so it’s better to rely on business loans or equipment financing for expenses of such magnitude.
To expand production capacity
As the demand for your products increases, the supply should increase as well. Expanding production capacity paves the way to cut down unit costs, thereby gaining competitive edge.
To accomplish this, you would have to purchase more advance technology. Here, technology not only refers to computer systems but also to new machinery and tools which can make the production process faster and more efficient.
To expand geographically
When you have secured enough monthly sales, the next step is to expand the business’s reach in other geographical areas. This will cost you a lot in terms of research and advertising. Building retail outlets in those areas will cost you a lot as well.
To take on acquisition
This is where a business buys another business in exchange for a large sum of money.
Things to consider when choosing a source of finance
Amount of money needed
Some providers are specialized in lending money to small businesses while some may prefer to see a bigger number on the paper.
Before taking on debt, first think whether or not you can pay it back on time. Calculate the DSCR or Debt Service Coverage Ratio by taking your average monthly cash flow and dividing it by the monthly payable loan amount.
If the result is greater than 1, the debt amount is within manageable limits but if not, you may have to consider going for a smaller amount.
The amount of risk involved
Finance sources, especially external ones, will refuse to lend money if metrics such as the credit score and time in business are low.
New businesses are considered to be risky and unstable therefore you will have to guarantee the return of at least a small portion of the loan. An SBA loan would be the best option here.
Too much equity financing will cause original owners to loose ownership of their own company and may even get kicked out. A good rule of thumb is to make sure you have at least twice the equity of all others’ combined.
Also, avoid risky investments. Investing too much money in such investments can lead to loosing valuable cash reserves.
But investing in blue-chip bonds, interest-bearing bank deposits, and trusted dividend-paying stocks would bring additional income to your business in a low-risk way.
Total interest to be paid
Any type of financing requires you to pay an extra sum of money as interest, in addition to the principal amount. Keep an eye on the total interest to be paid in order to effectively choose the cheapest option available.
Some sources of finance such as banks, take time to process and approve your loan. It may take days, or even weeks before you hear anything from them. If you are in a rush, you are better off going with invoice financing, and online lenders.
Financial management is the heart of any business. It’s what drives your business forward to meet its vision. Proper financial management allows you to prioritize expenses, and thereby cutting down unnecessary costs.
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