Understanding Business Finance
What is business finance?
Are you thinking about starting a business, buying a business or expanding your existing business then you’ll need some money and when it comes to money, even if you already have lots of it, some background on business finance is important. Here is what you need to know about business finance to get started.
Sources of Business Finance
A business can be financed under one of the two categories:
- Debt, money that you borrow and pay interest on; or
- Equity, money in exchange for an ownership share of your business. A dividend is paid on equity.
The difference between debt and equity
There are many different types of debt and equity. A main difference between them is how they are treated in a winding up of the business. Debt holders will rank ahead of equity holders if there is any money left over. Equity holders accept a greater risk of loss, but they also require a greater share of the returns.
Should my business be funded with debt or equity?
Business operators should aim to have business funding in both debt and equity. The level of debt versus equity can vary with the nature of operations of the business. For more information on this please visit our article ‘What to use debt finance for’. To understand the ratio of debt versus equity read our article ‘Business Finance using Debt or Equity’.
Which type of funding is correct for your business?
Some funding can be easy and speedy to organise, others will take more work and time. Some business funding will require you to use your house or other assets as security. Some business funding can be low cost, and some can be more costly. Some can be repaid and others you may be stuck with for life. Some can affect your management of the business. Understanding your situation is the key to choosing the best option for your specific business operations and needs.
Your growth goals & opportunities, your industry, and your business direction plus your business model needs to be understood before you can determine the level of each type of business funding that you need to achieve your goal.
How much business funding do you need?
Understanding the purpose and application for the money you require, along with the amount and timing is a key first step to choosing the business finance type. Here are some considerations when deciding:
- Starting a business
A business plan will help you to evaluate the level of funding that you need. Write down the problem your business aims to solve and why your new customers will flock to you, i.e. your value proposition. List all the things your business will need to get up and running including office equipment, desks, website development & hosting, building fit outs, rent deposits, cars and machinery, and right down to the paperclips. Also consider the timing and when you will need the money and when you can be ready to start trading and the cost of staff, insurances and any licenses or memberships.
Raising any form of business finance for a new business can be costly in some cases and it is often best to look initially to family and friends for seed funding. If you can convince your family and friends, then you are more likely to convince a third party.
2. Buying a business
Deciding a fair price to pay for an existing business can be involved and it is often best to discuss this with an independent third party and an expert. The amount you pay needs to based on the current profitability of the business and the value of its assets. For more information on this read our article how much to pay for a business.
An existing business will have accounting books or financial records and the current owner will be paying themselves a salary or a dividend and may also be taking drawings. There may be new equipment needed to buy and things like depreciation can help with this.
If you are not skilled in reading financial accounts, you should find an expert especially if you are also not familiar with the business or industry. This will help you understand how much money you will need to buy and operate the business. You may want to change the business through a rebranding or to add some new products and services. This will need money.
3. Growing a business
Growing a business can require investment in new staff, larger offices and more inventory and other operating costs. It’s a good idea to make a list of all the possible costs and expenditures involved. It may take time for the growth to appear as additional income so consider some timing to help calculate how much funding you will need.
Be proactively ready to work out what would happen to the operating costs post the expansion. You may require a bigger inventory and more staff. Check the budget and what it covers or does not cover, or if you can acquire a working capital loan.
What loans you must know?
Asset Finance Loan – a loan that can be used to acquire depreciating assets for your business and can create a matching cash flow effect for your depreciation. They often have a fixed interest rate and fixed payments. They can be a good approach for matching your cashflow to the replacement life of an asset. The asset can be used as security for the loan. For more info read our article on asset finance loans.
Working Capital Loan – is a loan to help bridge the timing between your revenue collection and your operating costs. As revenues can be unreliable but your payroll must be on time a working capital loan can even out the cashflows. A business needs to be ‘Bankable’ to secure a working capital loan. For more info read our article on capital asset loans and how to make your business bankable.
Capital Asset Loan – a loan that supports your acquisition of capital items including land and buildings. The land and buildings can be used to secure the loan. For more info read our article on capital asset loans.
Convertible Notes – a hybrid loan that can be converted to equity by the holder based on a predefined formula. Interest can be accumulated with the debt and qualify for more equity on conversion or paid to the holder. For more info read our article on convertible notes.
When to borrow money?
Professionally managed businesses are better at planning cash flows and getting them correct. Professionally managed businesses are more likely to secure loans at better interest rates as lenders consider them a lower risk of default. Preparing a professional funding request can help you to secure the funding you seek and at a lower cost. For more info read our article on preparing professional funding requests.
Avoid high-interest rates wherever you can
Higher interest rates can be paid on loans that are considered riskier by the lenders. Your accountant can impact this in the way that they present your financial accounts. To avoid high interest rates your business management skills need to be evident in your presentations. You can develop trust with lenders by articulating conservative targets and delivering sound results.
Seek expert help
Deciding on the type and structure of your business finance and arranging it can be complex and it is best to seek an expert to help you to avoid a costly mistake and give your business plans the best chance of success. Finance is important however your skill as a business operator is in developing products and services and securing customers for them at reasonable prices. Getting your finance wrong can cost you money and distract you from your main area of focus. Convergent Capital Corp has the expertise to ensure that you avoid the pitfalls so you can focus on developing & operating your business successfully. Call us now to turn your financial challenges into business success on 0429 33 50 18.
The information on this page has been prepared by Convergent Capital Corp for general information purposes only, without considering your personal objectives, financial situation or needs. Before acting on this general information, you must consider its appropriateness having regard to your own objectives, financial situation and needs. The information provided is not intended to replace or serve as a substitute for any accounting, tax or other professional advice, consultation, or service.
