There are a lot of highs in business and so many of them are quickly followed by a slightly sickening feeling.
From the high of seeing a new opportunity, winning a new contract or just seeing your sales pipeline grow, you can quickly move to a frightening feeling as you wonder how your business will perform in this newer, bigger state.
You know you will need a lot of resources. More people, more technology, more distribution, more stock more space and very often, more money.
This guide is about that final challenge. More money.
How will you fuel your growth?
When to look for finance
The best time to look for cash is when you don’t need it.
Running a business is stressful enough without the pressure of needing to raise money to meet the bills that are coming. So to avoid this, the best businesses are strategic in how they approach fundraising and have a fundraising strategy.
Sometimes they can plan years in advance, making the process well ordered and a bit simpler.
But sometimes, business opportunity knocks and you just don’t have the luxury of time.
If your funding needs are urgent, banks often aren’t the best lender. They usually look for safe investments and view business owners as risky ways to spend their money. This is why they usually ask for the family home to support the money you borrow.
So plan your funding needs, but always have your business in a good enough shape to go to the bank with a funding kit ready to go.
Where can you get funding from
There are 5 main types of financing available to any business owner:
Family and friends
Sometimes the funding choice of first resort, sometimes the last depending on your family! Family and friends can be a helpful leg up when your business starts or has great momentum, but be warned, what happens if things go bad? Despite your relationship, still get this documents through a family lawyer.
The big banks are a key part of funding growth, but expect to have to bring in some personal assets to prop up the loan (including the family home) and sometimes a longer than expected application process.
Credit Unions & 2nd tier banks
A bank may have a focus on a type of business and offer better deals because they have an expertise. For example, Bendigo Bank has a focus on lending to community minded businesses and RaboBank has a strong agrigultural focus.
Fintech Lenders are meeting some of the credit shortage created by the banks tightening their purse strings. Their loans are quick to draw for those times you can’t plan your funding need, but often have higher interest rates.
These lenders reward businesses who have up to date accounts, as they will often link directly to your cloud accounting file (using Xero, Quickbooks Online or MYOB).
Be careful though, whilst regulation is coming for these lenders, they legally do not have to disclose their full (known as effective) interest rate in their initial advertising. So make sure you really know what the loan is going to cost.
Credit cards are not a long term funding source. Their high interest rate can make long term credit card balances unaffordable.
They are very good for funding a short term gap between the time you need to pay for your stock or expenses and the time your client pays you for those goods.
Balance profit with growth
Good businesses with a track record of profitability and delivering what they say they do will usually get funded. However, if you are a growing business, with out that consistent history it can be harder, so it pays to plan.
Here are our best tactics that can form your finance strategy:
- Reduce spending
Profitability over multiple years is important to lenders. Not only does it prove you are a responsible business owner, but they can have faith that you can make the profit needed to pay for their debt in the future.
A profit strategy may see you prioritising a profit over other business options that involve spending money. This can cause a challenging balancing act as you may hold back investment in
- New marketing
- Renting larger premesis
- Hiring staff
You may wait for the funding to come in to invest in these items. Doing so will allow you to show the bank clearly what you are spending their money on, and how you will make more money because of their involvement.
- Increase sales on high margin products
Whilst generally good business practice, this tactic can become more important as you chase profit. In a growing business you may have chosen to take on customers who are not as profitable, or sell products for a lower price as you like to start wining your first bit of market share. You may want to revisit these tactics if you want to bring on some bank debt to grow.
Prepare your funding kit
If you are involved in start ups, you may have heard of the pitch deck. Its’s the sexy PowerPoint presentation you use to get investors to put money into your business.
A funding kit serves the same purpose, but for more established businesses. At a minimum it should have:-
- Up to date set of financial accounts
- The last accountant prepared accounts
- The last quarters mid year accounts
- Up to date tax returns
- Cash flow budget
- Supported by a matching profit forecast and projected balance sheet
The good news is these 3 items are a key part of any well run business, but discipline is needed to make sure they are consistently kept up to date.
The cash flow budget
‘’As a business banker I had to reject loan applications because cash flow budgets didn’t match what the owners where telling me’’ – David Boyar
The Cash Flow Budget is a main part of your funding kit because it tell the bank
- That you need the money
- What you will spend the money on
- How and when they will get their money back
It should only reflect actual strategies and tactics in the business plan you deliver to the bank. Whilst you can make assumptions about how your business will perform in the future, you will need to make some reference to how you have performed in the past.
For example, it will look suspicious if you used to collect your cash 30 days after issuing invoices, but suddenly plan to collect in 10 days.
The Cash Flow Budget should also tie into your profit budget and your projected balance sheet. These three documents are called a 3-way budget and is used to make sure you’re a complete story of your future is shown.
Getting ready to take on debt: The balance sheet
The balance sheet is the ultimate truth of your financial health. It records how much you owe, how much you are owed, what you have and how much you as the owner are entitled to. When you take on debt, that amount will be added to what you owe.
Make your debt/equity ratio attractive
The debt/equity ratio is a simple one to calculate, how much you owe the bank and other financiers divided by how much retained profit or your own contributions are in the business.
This metric shows the bank that you have financial skin in the game and they aren’t the only ones taking on risk to fuel your growth.
But it also speaks directly to the health of the business. If you add your desired debt and get a low ratio, it is a sign you may be growing too fast and can’t generate cash quick enough to meet the bank repayment.
Make sure you can afford your debt
The debt servicing ratio is another one that is easy to calculate. It is the profit over a period divided by the debt and interest repayments needed in the same period. It shows the banks your ability to pay them back.
A higher ratio, the better your ability to pay.
Using the profit tactics mentioned above is a great way to keep this ratio within target as well as knowing exactly how much debt you need to take on. There is no point going to the bank asking to borrow as much as they will lend without you knowing if you can afford it.
A well planned cash flow budget and projected balance sheet and profit and loss can test these ratios to help you build businesses tactics around what a bank might want to see.
If your business is going through growth book a meeting with a financial mentor.