As a business consultant with the University of Georgia SBDC, I have the opportunity to assist over a hundred businesses a year in the areas of management, marketing, technology, and of course, finance.
I say “of course” because if there’s one thing that no entrepreneur can do without, it’s money!
Sources of financing are varied, and each offers its own unique costs and benefits. Here are a number of options used by owners to finance day to day business operations such as purchasing equipment and inventory, hiring employees, and maintaining cash flow.
Debt – typically a loan from a bank or other financial institution
Advantages – low interest rates and longer repayment terms; borrower retains ownership control
Considerations – requires good credit, solid financials, and collateral for larger loans
Equity – cash from family, friends, and investors for a share of ownership in the business
Advantages – generally no payback schedule; less formal acquisition process
Considerations – owner loses sole control of business; profits are shared
Advantages – ease of application; short-term promotions; cash reward programs
Considerations – owner may be personally liable; high interest rates; relatively low limits
Purchase Order Financing – a cash advance against existing purchase orders
Advantages – don’t need stellar credit; owner retains sole control; no loan payments
Considerations – very high transaction fees; available to resellers only – no product modifications
Merchant Cash Advance – cash in exchange for a percentage of future credit/debit card income
Advantages – usually a quick source of cash; payback fluctuates with income
Considerations – very high interest rates and fees
Factoring – a cash advance against the collection of customer invoices
Advantages – not subject to traditional lending criteria
Considerations – high fees and interest rates; contingent on collection of customer invoice
Financing needs vary according to a business’s industry and life cycle. The ideal financing mix for a retail operation is quite different from the ideal mix of a distributor or manufacturer. Likewise, what suits the capital needs of a start-up company is rarely the best solution for a ten or twenty year old established business.
What is important is that the capital a business owner puts to work be as inexpensive as possible. Making minimum payments on a high-interest credit card while paying extra toward principal on a low-interest term loan is poor finance strategy. Similarly, depleting cash on a piece of equipment that you could finance at zero percent interest for a year may also not be the best use of capital.
Each financing option has its own time and place in the operating life of small business. Choosing which or what combination of options to use, however, should always be done in the context of sound strategic planning, not simply as an emergency response. For a consultative review of your business’s finance strategy, contact an SBDC business consultant today.