To start or grow a business, capital is required. Most businesses are started with the investment of the owners’ savings or through a bank loan, which are examples of methods of business finance. Raising finance is almost routine for a business and it’s done to either expand operations, accept new risk or to meet short term obligations. Sources of finance can be broadly categorised into debt finance and equity finance. Debt finance refers to capital that is obtained from banks or similar institutions in the form of a loan which charges an interest and must be repaid. Equity finance is capital obtained in return for an ownership or holding in the business. For small businesses, equity capital is generally unavailable and must therefore rely on debt capital to grow the business. Debt can also be classified based on repayment period as long term and short-term debts. In addition to debt and equity, a company may also elect to use its reserves of cash, or other liquid assets to finance their ventures. This article will describe several methods of financing with a particular focus on smaller organisations.
Using Internal Sources
Working capital includes inventory, cash, trade receivables and trade payables. Of these, inventory is the least liquid, but the others can be converted to cash relatively easily. Trade payables are essentially interest free finance and delaying payment allows the business to use the cash for other ventures provided that their creditors’ terms are not being violated. Doing this might be viewed as unethical and prompt unfavourable credit terms in the future or have debt collection agencies such as small business debt recovery Gold Coast attempting to recover the debt. Alternatively, a similar service or debt factoring can be used on the trade receivables to obtain finance through them in case the cash reserves are insufficient.
Using External Sources
External sources of finance for a small business are generally a bank loan. Before opting for external sources of finance, it is prudent to conduct an analysis into the need for debt. Several dimensions to consider are the nature of the need (whether it is within the scope of the current business model or is it to diversify), how urgent the need is, what the nature of the risks the business currently faces are, the state of the industry the business operates in etc. Ideally this would be conducted before the need for finance actually arises as it is easier to obtain a loan in a secure state of liquidity. Therefore, having some debt to face crisis or risk is prudent compared to attempting to gather finance in the middle of a crisis. The nature of risk and need are also metrics to be considered – if the new venture is within the current scope of business, it is likely the business has the experience necessary to complete it successfully and there would be no new risks. Conversely, if the venture is entirely new, acquiring debt finance may be more difficult as the lack of experience and new risks are apparent.