Financing Basics: How to Finance a Small Business

The success or failure of a business rests on whether it has a strong financial foundation. Sometimes it’s possible to finance a small business entirely from your own savings. However, what are your options if your money runs out before your business idea takes off? There are various ways to finance a business apart from using your own money, though you should be prepared to have a good, formal business plan if you want to attract capital from outside sources.

Government Financing

If you have no money, assets, experience, credit rating or friends and family to lean on, it will be very difficult to obtain external financial assistance. If your business isn’t somehow unique or revolutionary few financial institutions or investors will be willing to take a chance on you. Sometimes, governments back a business if that business rests on a particularly brilliant idea in a sector publicly supported by the government. These sectors are most typically the environment, technology, the arts or education. In the case of government grants however, there’s usually a mass of hoops to jump through before you’ll see any money.

Strangely, government grant officers will often make their loans subject to you being refused by a bank. This means you’ll have to go to a bank and get your loan application turned down before you approach the government for a loan. This may seem odd but it is protocol for a reason. If the government did not have this contingency in place, then banks would complain heavily that the government is taking away their business. Banks are therefore given the first bite of the apple before the government gets to see the people the banks are not interested in.

Forecast Your Cash Flow Needs

Before you think about available options to finance your business, you’ll want to determine exactly how much money you’ll need via a cash flow forecast. The bottom line of a cash flow forecast represents how much money you’ll need and when you’ll need it.

If you make children’s games your costs may be high during the summer months when you manufacture the games. But, as most of your customers will not be invoiced until early December for the Christmas retail period, this means you’re effectively waiting up to nine months to recoup your costs. The question is, how do you survive in the meantime without an injection of capital?

You need to draw up at least three cash flow forecasts- worst case, best case, and optimum case scenarios. These forecasts will help you predict the amount of money you’ll need when things go wrong, if they go well, or if the business pans out exactly as you expect it to. Each of the three scenarios will dictate different amounts of financing, of course.

Bank Financing

Proving that you need money is only the start. Few people are going to offer to fund your business without some form of guarantee. You’ll also have to prove to potential investors that if they lend you money, they’ll get it back. Banks will almost always provide loans against property or other assets that you might own. Usually, both banks and investors will also want a personal guarantee in writing. This will provide them legal access to whatever assets you’ve pledged to secure the financing.

A bank will usually only provide a loan if it is secured by property. Contrary to what many people believe, banks rarely take risks. They want to know that if everything goes badly with your business, they’ll get their money back along with any interest they might be charging.

If you do approach a bank, then it’s important to be upfront with them. Let’s say that you’re approaching a bank for a loan. If you need $15,000 in February plus another $20,000 in June, give the bank manager that information. This prevents alarm when you submit an additional application for $20,000 without warning.

Alternative Financing

Factoring, leasing, and hire purchase financing are alternative financing options. These types of financing are usually only offered by finance companies. As such, it’s best to shop around, ask a lot of questions and get a lot of quotes. Be aware of the small print to ensure that you don’t end up paying unreasonable finance rates. Finally, it’s worth considering short-term credit cards as an option in some circumstances. Remember that this is true only if you pay the balance in full each month. Most banks don’t charge interest if you pay off the full amount owed at the end of each month.

Financing a business can be a challenge, especially if you are the sole owner of the company. Rest assured that there are plenty of options to realize your dream of innovating and expanding. With a little creativity, passion, professionalism and planning, you’ll establish a good foundation for success.

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Kevin A. Nye
Small Business Consultant, Advisor, COO
A veteran of multiple industries, Kevin A. Nye has parlayed more than 20 years of management and leadership experience into a consultancy designed specifically for the benefit of small businesses. Having served in roles in Supply Chain, Operations and Regional management, Mr. Nye was most recently the Chief Operating Officer of a regional steel company and is currently focusing his expertise to help entrepreneurs define and implement strategies that add value to their businesses.

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