Small Business Finance

shutterstock_136652339The number one reason small businesses fail is insufficient cash flow. The money coming in is less than the money going out, which eventually makes the business insolvent, or unable to pay its debts.

Running your own business requires a basic understanding of finance and this article looks at the need for finance in a small business, where to get it and how to manage it successfully.

Need for finance

When you start your own business, you need startup capital and unless you’ve managed to save it, you’re going to have to borrow it. Small business startup expenses are many and varied and may include:

  • Premises – Unless you’re working from home, you’ll need to lease office or factory space and storage space for stock.
  • Plant and equipment – This includes everything from office equipment to machinery needed to manufacture your product(s).
  • Vehicles – This may include a van, truck or other company vehicle(s), depending on the nature of your business.
  • Inventory – If you are making or selling a product, you will need to have stock on hand when you start your business.
  • Licences and insurances – You will need to register your business and fully insure it, along with any staff you may be employing.
  • Operating costs – You will need to have these covered for a few months ahead at least when you first open your doors.

Sources of finance

There are several places you can source your startup capital from and each has its own particular pros and cons.

  • Personal savings – Many small business owners tap into their own savings to fund their business and while it is tempting to do so, it should be avoided unless there is no other source of funds. This is because if the business fails, you will no longer have a retirement nest egg. Using your home as collateral for a small business loan is also a risky course of action for the same reason.
  • Friends and family – This can be an option, particularly if they are involved in the business anyway (i.e. many small businesses employ family members). The danger here is that if the business fails and you are unable to pay them back, you risk damaging personal relationships.
  • Business loan – If you go to a bank for a small business loan, you will need to be well prepared and be able to provide a detailed breakdown of what you need the money for and how you will be able to pay it back. If you don’t qualify for a bank loan (and many small businesses don’t), prepare to pay a higher interest rate from another lender.
  • Line of credit – The qualification requirements for a business line of credit are generally less rigorous than for a business loan. A line of credit is an unsecured loan that gives you access to money as you need it. It may not be a suitable option if you only require a small amount of startup capital however, as many banks only offer lines of credit for larger amounts.
  • Venture capital – These days, there are lots of opportunities for startups to attract financing from individuals and groups who invest in new businesses. The main drawback of obtaining finance in this way is that you will relinquish some or all of your control over the business.

Finance problems and solutions

The main financial problems faced by small businesses once they are up and running are not having enough cash flow, having too much debt and not managing their finances properly.

As mentioned previously, insufficient cash flow is the number one reason for small business failures. Cash flow is calculated by subtracting your expenses from your income. Whatever is left is cash flow – the money that is available every month to pay your running costs and expenses.

If your cash flow is insufficient, you will struggle to grow your business and pay your debts and the solution is obviously to generate more cash. This can be done by taking on a partner, restructuring the business (i.e. turning it into a family trust or a proprietary company), or inviting employees to take shares in the business.

Another, less drastic, measure could be to concentrate on your accounts receivables and encourage earlier payment with discounts and incentives. You could also negotiate longer payment terms with your suppliers, adopt just-in-time inventory management practices and basically take any measures you can think of that will lead to cash coming into the business faster than it goes out.

Another finance problem faced by many small businesses is carrying too much debt. The more debts you have, the more likely it is that your cash flow will be eaten up by bills each month, instead of being used to improve your business.

Ways to reduce debt could include shopping around for a better interest rate on your business loans, consolidating various debts into one low-interest loan and asking your suppliers for discounts and incentives.

Another way to reduce debt could be to sell expensive assets and then lease them back; a process which turns a depreciating asset into a tax-deductible expense. You could also consider outsourcing some elements of your business, thus removing the need for plant, equipment and labour.

The third main problem many small businesses have is poor financial management practices. Not keeping finances in good order can lead to costly errors and oversights which can add to your debt and reduce your cash flow.

Good financial management techniques include:

  • having a business plan
  • having a budget and sticking to it
  • keeping accurate and up-to-date financial records
  • using proper finance and accounting tools
  • having strict accounts receivable practices
  • paying bills promptly
  • reviewing your financial situation regularly.

Starting your own business can be a daunting prospect, highlighted by the number that fail in their first year. But understanding your finances and paying as much attention to them as you do to the day-to-day operation of your business will give you a much better chance of still being around in the second year and actually making a profit.

Jarrod Kagan
Having practised at a major law firm before moving across to Probe Group (one of Australia’s most prominent credit management organisations), Jarrod has over 8 years’ experience in credit management and debt recovery. He now holds the position of Head of Business and Compliance and as a qualified Lawyer, his skill level and experience covers the technical aspects of credit management and debt recovery, including: best practice, compliance, legislation, strategic analysis and industry specific detail.