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The means with which you finance your business is pivotal in determining how profitable you will be in the future.
The way you finance your business is one of the key factors that will impact on how profitable you are. There are three main ways to raise capital:
- Shareholders’ equity – yours or other investors’ money.
- Reserves – profits put back into the business.
- Borrowed funds.
If you have decided to raise capital by borrowing money, you need to consider what source and type of finance will suit your needs. It is important that you match the method of funding and term of the loan to the purpose for which the finance is being used. Be aware that your financing decisions can seriously impact on business cash flow and taxation obligations.
How Much Capital?
You need to make a realistic assessment of your financial needs, including start-up costs and how long it will take before your business can become self-supporting. This will form part of your business plan and is essential for your loan application.
Your assessment needs to demonstrate that you will be able to repay the loan, taking into account possible risks such as lower than forecast sales or increases in interest rates.
Types of Finance
Short Term Finance
This form of finance is commonly called “working capital”, required to fund the day-to-day running of the business. Working capital should not be used for long-term projects as it is generally more expensive (in terms of interest rate) than money paid back over a longer period. Some examples are:
- Bank overdraft – An overdraft can be used to cover cash flow shortfalls from day to day. The interest will be calculated on your daily outstanding balance and is usually charged on a quarterly basis. Depending on your financier, an overdraft facility may also incur other fees.
- Commercial bill – An arrangement where money is made available for a short period, at the end of which you must repay the borrowed amount. Commercial Bills can be drawn for terms ranging from 30 days up to a maximum of 180 days. They are commonly used to meet the seasonal funding needs of a business.
- Debtor finance – An arrangement where a finance company provides a cash advance to the business against sales made (invoices). The “loan” is repaid when the debtor pays the invoice.
- Trade credit – A short-term source of finance obtained by buying goods and services that do not require immediate payment. If managed carefully, this can reduce the capital investment required to operate the business.
Medium Term Finance
Usually required for a 3-10 year period, this is principally used to finance equipment, business expansion and development of new products. Examples are:
- Term loans A loan paid back over an agreed period (term) where principal and interest rate are paid off in monthly repayments. It is commonly used by businesses wanting to structure their loan repayments to correspond with the income produced from equipment purchased or sales of new products. It may be for a five or 10 year period.
- Personal loans Where it is not possible to arrange a loan in your business name you could consider arranging a personal loan. This can then be contributed as equity or as a loan to the business.
- Leasing The financier purchases the equipment you require and then leases it to you in return for regular rental payments (usually monthly) for the duration of the lease period. At the completion of the lease term you are offered the option to purchase the equipment at an agreed residual value.
Long Term Loan
This type of finance is used to fund the purchase of assets such as the business itself, land, buildings, plant or machinery which will directly or indirectly contribute to profit over a period of years. Term loans would be the most common way to structure long-term borrowings.
If you require advise or assistance regarding setting strong and achievable financial goals or deadlines for your new business, please don’t hesitate to contact The Quinn Group through our online enquiry form above.
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The Quinn Group operates Quinn Consultants, Quinn Lawyers, Quinn Financial Planning and Quinn Financial Solutions. The Quinn Group provides related information in regard to legal, accounting and financial planning issues. Liability limited by a scheme approved under Professional Standards Legislation* *other than for the acts or omissions of financial services licensees.