All businesses usually need help with financing at some point in time. The process begins by estimating financial needs based on projected financial statements. These statements, along with a sound business plan, enable a business to analyze where to seek financing -- from within the business itself or from an outside lender.
When is financing required?
During start-up, financing may be needed to cover:
Ongoing day-to-day expenses such as payments to employees, for rent, and if applicable, to purchase inventory. A business should have enough funds to cover a minimum of two to three months operating expenses and a cash reserve for emergency situations. This is called working capital.
Projecting Your Financing Needs
Estimating financial needs begins by preparing three projected financial statements which include an income statement, a cash flow, and a balance sheet. These are also called 'pro forma' statements. Based on the statement data, you can then prepare a breakeven analysis.
Income Statement
A projected income statement estimates your total expected revenue and expenses for at least the first year of operation. It includes data about your predicted sales volume, how much it will cost you to produce or purchase the goods or services you intend to sell, and your operating expenses such as utilities and rent. Net income is the difference between revenues and expenses. Simply put, if revenues exceed expenses, a net income is projected; if expenses exceed revenue, a net loss is projected.
Cash Flow Statement
Many businesses fail because they neglect to plan for future cash needs. A cash crisis occurs when they have bills to pay but not enough funds to pay them.
A projected cash flow statement attempts to show the flow of cash in and out of a business over a period of time. Usually there are ups and downs; revenues and expenses vary from month to month. Also, in many small businesses, not all sales are cash. The statement also helps to project when credit sales will turn into cash collected. Once prepared, a projected cash flow statement becomes a cash budget which should be continually reviewed. In general, the cash flow projection/budget helps a business avoid cash shortages, monitor receivables, schedule expenditures, and establish a line of credit.
Balance Sheet
A projected balance sheet outlines what you forecast your business will own (assets) minus what it will owe to others (liabilities) in order to determine its net worth at any particular point in time. Assets are resources such as inventory, cash, or equipment. Liabilities are debts owed to others, both short-term and long-term.
Breakeven Analysis
After you have completed the above three pro forma statements, you should address a vital question: What is your breakeven point-- at what point do your total costs equal your total revenue? The breakeven point tells you when you can expect to begin making profits.
It is essential to know this before you proceed with your enterprise. Lenders expect to see this information in addition to the other statements, as part of your documentation. Ultimately, if it appears that the breakeven volume of sales cannot be achieved, then the business may be destined to fail and should be abandoned before investing further time and money.
Once established, a business should produce these financial statements on a regular basis. For more details, read some of the many books available at the Canada/Manitoba Business Service Centre.
Finding Financing Within The Business
Although most people usually think of obtaining financing from outside sources, it is possible for a business to free up some of its own funds by:
Conserving capital through measures such as renting space instead of buying. However, short-term measures may lead to less stable long-term positions.
Finding Financing Outside The Business
If you seek financial help outside the business, you must demonstrate two things: a feasible re-payment plan, and that you are willing to invest and risk a reasonable amount of your own money in the business. Approach lending institutions only after you have explored every avenue of your business for earnings and savings, and can demonstrate this fact. In general, there are two types of financing:
Equity-
Most small businesses are funded initially through their owner's resources and personal savings. Additional funds may come from family or friends. However if the venture fails, hard feelings can result. Make sure you have a formal legal agreement that outlines all terms and conditions.
Equity financing can also be obtained by 'going public' (offering shares in the business to the general public) and from venture capital firms (which supply money in return for part ownership). These last two forms of equity financing can be complicated, and are usually not undertaken by small business start-ups.
Debt-
Debt financing can be compared to renting money. You repay the debt plus a fee (interest) for renting the money. Most businesses at some time or another need to look at debt financing, either from a bank or financial institution, or from a government lending agency.
There are various forms of debt financing, depending on the loan's purpose and the business situation. Some of these include fixed assets financing, working capital financing, accounts receivable financing, and inventory financing. Regardless of the type, be sure to observe the cardinal rule: avoid imbalance. Long-term financing should not be used for short-term working capital, and working capital should not be used to purchase long-term fixed assets.
Approaching a Lender
In all dealings with a lender, build a reputation for integrity and honesty. Observe policies, and regularly inform your lender about business developments.
Basic Accounting Records
Day-to-day accounting records depend on the size and scope of your business. These records can include a cash receipts journal, cash disbursements journal, payroll journal, accounts receivables ledger, accounts payable ledger, sales journal, purchases journal, and general ledger. For any business except the smallest of operations, the services of an accountant are usually required.
DISCLAIMER
Information contained in this document is of a general nature only and is not intended to constitute advice for any specific fact situation. Users concerned about the reliability of the information should consult directly with the source, or seek legal counsel.
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