There are many things to manage when you run your own business – for example, maintaining a healthy cashflow, balancing the books, growing sustainably and choosing the right kind of finance for your business needs.
One size doesn’t fit all when it comes to accessing funds for your business – there’s short and long term finance, internal and external finance and a number of different criteria to consider before choosing which best suits your situation. Let’s examine some of the options.
Factors to Consider When Choosing Finance
Before you can determine which type of finance is right for your business, you need to establish what kind of loan you require and for what purpose. For example, how quickly do you need to access the funds? If the money is required for paying wages, rent or another bill to prevent the shutdown of your business, you’ll need the money without delay and will likely have to pay a higher cost to get it. However, if you want funds for long term capital investment in machinery or new staff, you can afford to wait to get the best deal available.
The loan amount you require is also significant in deciding the right source as some types of finance are only feasible for small business loans. Similarly, the length of time you’ll require for repayment is something you need to factor in before applying. You have to be realistic about your repayment goals so that you don’t overstretch your business and damage its ability to operate satisfactorily. Another matter to weigh up is the risk factor. Higher risk ventures may be harder to attract financing for or they may come with higher costs involved.
Leveraging Your Finance
One final consideration before deciding on a source of finance is the cost of the finance itself. This means the amount of extra money you’ll need to borrow in order to secure the loan amount, typically calculated as interest. Whatever the total cost of repaying the loan with interest, it should be less than the projected profit you’ll make from investing the loan amount. The more profit you can make on the money with the least associated repayment costs, the better you’ll be leveraging that finance. Of course, this isn’t an option if you’re using the money to stave off closure – in this case, you simply need to ensure you can repay the loan while you find a way to stabilise the business and improve your cashflow.
Short Term vs. Long Term Finance
Short term finance is money that you need to cover the day to day running of your company. This kind of finance is intended to be paid back in a matter of months rather than years, so there’s less risk involved for the lender. Typical examples of short term finance include bank overdraft, working capital and suppliers’ credit. In contrast, long term finance is generally used for larger projects or ventures that will be repaid over a longer period. As there is more risk involved with long term finance, lenders often ask for additional security to safeguard against bad loans. For example, mortgages are secured so that if you don’t repay the loan amount, your property may be repossessed by the lender and sold to recoup the money owed. Bank loans, hire purchase, debentures and retained profits are all examples of long term finance.
Internal and External Finance
Internal finance is money that comes from your business trading. This may include customer sales, credit extended by suppliers, the disposal of surplus business assets and reductions in stock. As you won’t need to pay interest on money raised internally, it’s the cheapest form of finance for businesses. However, raising money solely through internal sources may not provide enough revenue to fund a larger investment project. For these, you will probably need to seek external finance – for example, through a bank or building society loan, the sale of company shares or the release of equivalent equity in your business.
Just as there are many reasons why a business might need extra money, there are many sources of finance to choose from. Selecting the right kind of finance for your business requires you to weigh up the pros and cons of each and carefully consider your own business needs.