Financing the new enterprise One of the primary goals of starting a business is to make money.

However, it takes an undeniable amount of capital in order to properly launch and sustain a business. This amount of money for a given venture has to do with the unique goals and needs of the entrepreneur. It is crucial for a new business to develop resources and additional means to obtain further capital because without proper financing, a new enterprise may find it extremely difficult to compete with an already established competition. In addition, the lack of funding may also lead to a company closing or even worse, bankruptcy. It is important to consider the pros and cons of different financial sources that are available in order to make an effective educated decision to fund a startup. Bootstrapping This term refers to a company owner who decides to solely fund their business on their own without depending on outside sources for financial support. In this type of funding, the entrepreneur often evaluates all of his/her assets, including personal savings accounts, credit cards, equity in real estate, retirement accounts, vehicles, recreational equipment, and even collectables. By assessing their personal assets, a business owner can easily generate cash if they decide to sell their property. They can also use these possessions as collateral for a future loan. The more money that an entrepreneur uses on their own for their business, the more likely they will acquire capital from other sources when they need it in the future. Pros- When business owners decide to bootstrap their business, they are able to gain complete independence of their company and avoid having a diluted role when investors, directors, etc. are introduced. Cons- Unless the business owner is rich, they will have much financial constraint when using their own finances. Their company may be underfunded, they may underestimate business costs, and/or do not have the resources and support (financial advisors, mentors) that the business needs to successfully take off. Bootstrapping entrepreneurs also have the tendency not to write a business plan, which increases their chance of failure since the business is less likely to be researched, analyzed, or have outside feedback. In addition, many people use credit cards to fund the costs of their startups. Even though this is a quick and easy way to obtain the money that is needed, they end up spending large amounts on the credit card interest payments. Friends, family, business associates When self-financing is not enough to provide the needed capital for a startup, business owners usually turn to their families, relatives, friends, and business partners for further financial support. These people tend to provide much needed support to the entrepreneur and enjoy the excitement and success of the new venture. Pros- Loans from family, friends, and partners can be obtained quickly since they share with the entrepreneur a relationship that is based on a more personal level. Business owners have the benefit of not paying back interest or providing a monthly payment as bank loans require. Cons- One downside of borrowing money from friends, family members, and associates is the fact that the entrepreneur may give up more ownership of their company. The more partners involved, the more profit will be divided among all members. Friends and relatives who provide business loans sometimes feel that they have the right to offer suggestions concerning the management of the business. Their suggestions may sometimes be contrary to the entrepreneurs strategy and may even strain personal relationships. Entrepreneurs should repay the loans as quickly as possible in order to avoid interpersonal conflicts among family members and friends. Government funding Government funding is financial assistance the government gives to eligible people and businesses with no payback requirements. This is a common procedure in most governments and is done for many different reasons.One aspect of government funding is the fact that the money given is not repaid by the person or business who received it. It is not considered a loan, but rather a grant. Most government grants must be applied for before they are given. Some grants are won through entering a competition against other people or businesses. Others are just given out if applied for and accepted. Governments give financial assistance for many different reasons. Government funding is given to schools and states. It's also given to small businesses, minorities and people wanting to attend college. Many times the government offers funding to stimulate the economy. By promoting education, people obtain better jobs. Better jobs leads to more income which is spent in the economy. Most types of government spending can stimulate the economy in some way. Pros- Funding provide a good way to and promote a better interaction between local lenders and borrowers. These loans will also increase the chances of an entrepreneur to get a bank loan.

Cons- The guidelines are strict and the network of lending partners may reject applicants based on income, assets, type of business, past experience, etc. Commercial finance companies There are non-bank commercial lenders (aka commercial finance companies) that can also offer money to business owners. Unlike banks, they are willing to look beyond ones credit history and assets in order to provide the needed capital for startups. Commercial finance companies have emerged in recent years and give opportunities to companies that banks will not lend money to. Pros- Non-bank commercial lenders look beyond financial history and possession of assets and will lend money to companies who have been turned down by banks. Cons- These lenders often require a business plan, personal financial statements, cash-flow predictions, and the borrower to provide 20-25% of the needed capital themselves. Personal loans Another good way to obtain needed capital is by getting a personal loan rather than a loan under the business name. There are two common types- a home equity loan and a home equity line of credit. Home equity loans provide a valuable source of funding for startups. The entrepreneurs home is the collateral and the borrower is locked into a fixed term for five to thirty years. Home equity line of credit is a line of credit that is granted to the borrower. Their home is the collateral and they only pay interest on the amount used. Pros- Both types of loans are widely available through many financial institutions. The business owners home is the collateral and interest is tax deductible. Cons- One disadvantage for home equity loans is that they are comparable to an additional mortgage on your home; if the borrower cannot make repay the amount, their home may be at risk for foreclosure. These loans are also risky in the sense that if the business fails and the entrepreneur is not able to make payments, their home will be at risk. In addition, if a borrowers house value drops, they may end up owing more on their property than it's worth, especially if they plan to sell their home in the near future. Insurance policy loans A policy loan is a loan that is issued by an insurance company to an individual that uses the cash value of a person's life insurance policy as collateral. The individual can borrow up to 80% of the surrender value of his/her life insurance policy. Pros- There is flexible repayment options where the borrower can repay the loan in whole or in part at anytime. Cons- Traditionally, these were loans issued at very low interest rates; however, this is no longer true. In addition, if the borrower (the entrepreneur) fails to repay the loan, the money is automatically withdrawn from the insurance death benefit. Angel financing Angel investors are wealthy individuals who like to invest in small start-up enterprises. When they invest their money into a business, it is not considered a loan. Instead, they desire an agreeable percentage of stock or share in a company for their own financial gain. Pros- Most angels have experience in the industry of their investment and most likely have been successful business owners themselves. They can act as effective, obliging advisors and mentors to entrepreneurs on how to make their business thrive. In addition, they offer a large sum of money that may not be available from other sources. Cons- Angels often require a percentage of stock or shares in their invested companies. This means that entrepreneurs may have to give up some control of their businesses. To read more about the Pros and Cons of Angel Investing, please refer to our related articles. Venture capitalist financing Venture capitalists usually prefer to invest in companies that are in their later stages of development.. Like angel funding, venture capital rupees are invested in exchange for equity (an ownership share) in a company. VCs obtain their money out only when the business is acquired by another company or "goes public," that is, when its company shares become publicly traded on a stock exchange.

Pros- Venture capital can help business owners expand their companies and obtain market share. Cons- By obtaining venture capital, the business owner will no longer be the sole owner of your company and may lose control. Moreover, a VC may move their invested company towards an Initial Public Offering (IPO) of publicly traded shares faster than might be best for the long-term health of the business. Financial Management for new ventures Managing the finances of the business can be a challenge. To survive and thrive, one must earn profit consistently, generate cash flow from profit, and control your financial condition. One needs a separate financial statement to highlight each aspect:

The P&L Statement (also called the Income, or Earnings Statement) summarizes revenue and expenses and reports your resulting profit or loss thats what the P and L stand for. The Statement of Cash Flows begins by reporting the net increase or decrease in cash from your revenue and expenses during the period (which is a different amount than your profit or loss for the period); this statement also summarizes other sources of cash you tapped during the period, and what you did with your available cash. The Balance Sheet (also called the Statement of Financial Condition) summarizes your assets and liabilities at the close of business on the last day of the profit period and reports the sources of your owners equity (assets less liabilities). Make sure that you know how to read and interpret the financial statements. Not understanding the businesss financial statements puts a serious disadvantage in making good business decisions and in dealing with your lenders and owners. Of course, the information in your financial statements is no better than your accounting system. Hire a competent accountant to design and run your accounting system. Your accountant can be a valuable helpmate in managing your financial affairs. Dont confuse your balance sheet with the market value of your business. True, your balance sheet reports your assets and liabilities, and the difference equals the book value of your owners equity. Keep in mind, however, that historical costs are the values for many assets, and the balance sheet does not report your profit performance over recent years. Yet, the market value of a business depends heavily on current replacement values of your assets and your recent profit performance. Paying Attention to Profit in Business Your small business is designed to make a profit even if youre not making one yet. Managing the financial aspects of profit requires special skills and powers of recognition. The following list offers tips on what to pay attention to:

Cash flow accounting doesnt tell you profit for the period, and accrual-basis profit accounting doesnt tell you cash flow for the period. Credit sales are recorded as revenue before cash is received. Some expenses are recorded before cash is paid, and some are recorded after cash is spent. Depreciation expense is not a cash outlay in the period. Never confuse profit and cash flow. You need to look at your P&L report for your profit, and you need to look at your Statement of Cash Flows for your cash flow. Use a compact profit model for decision-making analysis. The P&L report is indispensable for controlling profit performance, but this profit performance report is too bulky for decision-making analysis. A compact profit model is better. The P&L statement is like a high-end digital SLR camera; a profit model is like a pocket-size digital camera that you carry around with you and is good enough for most uses. Seemingly small changes in profit factors can cause staggering differences. A small slippage in the ratio of margin on sales revenue can have a devastating impact on profit. A slight boost in sales price or a relatively modest increase in sales volume can yield a remarkable gain in profit. Small changes mean a lot.

Make the Most of Businesss Assets The assets of your small business drive your financial picture to a large extent, so you need to know how to manage those assets to maximize their use to you. Use the tips in the following list to help put your assets to work for your business:

Determine the sizes of assets you need to support the level of your annual sales revenue. The amount of your total assets determines the amount of capital you have to raise, and capital has a cost. The more assets you have, the more capital you need. Downsize your assets as long as you dont hurt sales. Dont rush into securing debt and equity capital without doing due diligence. Many small businesses are desperate for capital. Carefully examine the true, total cost of the capital and scrutinize the potential for interference from capital sources in running your business. Businesses that make profit generate taxable income. Small business (S) corporations, partnerships, and LLCs (limited liability companies) dont have to pay income tax. They are pass-through tax entities; so, their owners include their respective shares of the businesss taxable income in their individual income tax returns. The profit of a pass-through business is taxed only once in the hands of its owners. Cash dividends paid to stockholders by regular (C) corporations from their after-tax profits are included in the individual income tax returns of their stockholders and are thus subject to a second tax in the hands of the stockholders. To keep your assets working for your business, trust, but protect. Business is done on the basis of mutual trust, but not everyone is trustworthy, even a longtime employee and a close relative. Enforce effective controls to minimize threats of theft and fraud against your business. An ounce of prevention is worth a pound of cure. Plan Ahead for Business As the owner or manager of a small business, of course youre very busy, but it pays to step back and plan for your financial future. Take the time to forecast, plan, and budget. Have your Controller (chief accountant) prepare the following pro forma (according to plan) financial statements:

Budgeted P&L statement for the coming year. Even if this budgeted P&L is abbreviated and condensed, it plays an invaluable role. Provide your Controller your best estimates and forecasts for sales prices, costs, and sales volume during the coming year. From this information your accountant can prepare a P&L that serves as your performance benchmark as you go through the year. Dont be afraid to change the budgeted P&L in midstream. Sometimes totally unpredictable events make your original P&L budget out of date. Budgeted Balance Sheet at end of coming year. You dont necessarily need a detailed listing of every asset and liability one year off. But you definitely should look ahead to your general, overall financial condition one year later. Its better to spot problems earlier than later. Looking down the road at where your financial condition is heading can help you avoid major problems. Budgeted Statement of Cash Flows. Preparing this budgeted financial statement is an excellent way to keep close tabs on your cash flow from profit (operating activities) and how you plan to use this cash flow. If you are planning major capital expenditures (new investments to replace, modernize, and expand your long-term operating asserts) a budgeted statement of cash flows is essential for making strategic decisions regarding how you will secure the cash for these expenditures. Sources Of Business Finance The initial investment that an owner puts into a business is known as capital. The source of this capital may include money from savings, redundancy, inheritance, investments, winnings etc. When the business becomes established, capital may be increased by retaining an amount of profit that the business earns. These are all internal sources of finance. External sources of finance are available for businesses to draw upon if internal sources are not sufficient. These external sources of finance can be classified into three main categories. These are short term, medium term and long term sources.

Short Term Sources of Finance Short term sources of finance are usually used to provide additional working capital which is needed to fund the day to day activities of a business. These activities may include replacing stock which has been sold and therefore converted back into cash. Short term finance is generally considered to be over a period of one year or less. These sources of finance include:

Overdrafts- This is a type of bank loan is set up on an account which can be used if required to provide additional working capital for a short period of time when there is a cash deficit. This type of loan tends to attract a high interest rate which makes them quite expensive. How much of a risk the bank considers the loan to be will an affect the interest rate considerably which is often determined by a credit rating score. If the business needs money for a fixed period of time which is less than one year it could be more appropriate to set up a short term loan from a bank or even borrow money from family or friends. Banks may charge a set up fee for a bank loan and will be paid back in instalments. Some sort of collateral or security for the loan will usually be required by lenders so that if the business defaults on its payment it can recover any outstanding payments by taking claim to any assets than were used as collateral. For new businesses the collateral used is usually the business owners house or car. Trade credit- This is provided by trade creditors who are a supplier whom the business has purchased goods or services from on a credit basis. This means that the business does not have to pay its supplier straight away and has until the end of the credit period to pay for its purchases. The credit period is a length of time specified by the supplier which is based on a businesss credit rating. This is usually between thirty and ninety days. Suppliers may offer a discount on purchase for prompt payment before or by the due date. Trade credit is not a direct source of finance but it does make it possible for money already within the business to be directed elsewhere until it is needed to pay creditors. Factoring- This is where finance is raised against trade debtors. These are customers who have purchased goods or services from a business on credit but have not yet paid and have usually breached their credit terms. A factoring organisation which is usually a bank or another financial institution will assess how credit worthy the debtors are and proceed to attempt to collect the debts on behalf of the business. This is done for a fee which is determined by the amount of financial risk involved regarding the debtor. Once the debtors have been passed on, the business can get the value of the invoice minus the fee immediately (dependent on the agreed terms).

Medium Term Sources of Finance Medium term sources of finance are usually repaid over a period of five to seven years. This is usually used to purchase assets that are expected to generate income for the business over the medium term which may include office equipment, plant, fixtures and fittings or vehicles. This type of finance is secured against business assets or the owners personal assets depending on what type of company it is. These sources of finance include:

Medium term loan- This could be obtained from a bank, a government scheme or friends and family. It would most likely be used to purchase an asset over a fixed period of time which will be linked to the expected economic life of the asset. The conditions of the loan are similar to that of an overdraft or short term loan. Hire purchase- This is a more flexible approach to traditional borrowing. HP allows a purchaser to start using an asset as soon as a deposit has been paid. The deposit represents the first payment of a number of instalments which are paid over a specified period of time at regular intervals. The ownership of the asset does not pass to the purchaser until the final instalment has been paid. This type of finance can carry quite a high interest rate but may be better for a business as payments are spread out over time. Leasing- This can be used to acquire assets at a lower cost than would be necessary to purchase outright. Leases are usually paid monthly or yearly. A business may use this option is the residual value of an asset is likely to be uncertain when it comes to selling the asset or if an asset is only required for a certain period of time.

Long Term Sources of Finance Long term sources of finance are used to obtain assets that are expected to provide economic gain or benefit to the business in the long term. This type of finance is usually considered to be longer than seven years and can be divided into two categories which are debt finance and equity finance. These are the main sources of debt finance:

Long term loan- This would be suitable for capital investment in fixed assets such as plant and machinery or to expand the business. Mortgage- A form of long term loan that is used to purchase land or premises. A mortgage in usually provided by a financial institution such as a bank or building society. They have a specified time frame over a number of years where the loan has to be paid back which is usually around twenty-five to thirty years. The interest rate can either be fixed or variable. The amount owed can either be paid in instalments or at the end of the term of the loan. Debenture- The most common type of long term loan taken out by a limited liability company. Repayment is usually made in full at a fixed date in the distant future. The holder of the debenture could be a private or corporate investor and typically receives a fixed rate of interest. Debentures are lower risk for the investor than an equity agreement and can be sold on the stock exchange.

Equity Finance Equity finance refers to finance raised by the selling of ordinary shares. This makes it possible for only limited liability companies to use this source of finance. Below are the types of equity finance:

Sell shares- Public limited companies can sell shares on the stock exchange to raise capital. The rules of the stock exchange are very strict and involve a lot of regulation. On the stock market there is a minimum amount of shares that have to be issued, trading records are required and there is a minimum market capitalization. Formal venture capital- These are from corporate investors such as pension funds, and they generally provide equity finance for new businesses or for situations where there is a turnaround such as a management buyout. Only investments that offer high returns to offset the high risks will interest a venture capitalist. Informal venture capital- Business angels generally provide this type of equity finance for small to medium size enterprises. A business angel is usually a wealthy individual who want to invest in a privately owned business which are usually private limited companies.

In conclusion, the source of finance that a business will try to obtain is dependent on the reason the finance is needed. A business would have to examine what its requirements are and what its financial position is at the time. Only then could they make the correct decision as what type of finance will be right for them.