There are two basic kinds of business finance, equity finance and debt finance. Broadly speaking, equity finance funds lent to a business by a shareholder and returned with interest and/or equity in the business. The other type of finance is debt finance. Debt finance is basically paying back debt, i.e. making payments on borrowed funds using the business’s assets (usually equities).
Many business owners find themselves at an impasse over whether to invest in short-term assets or in long-term assets. Short-term factors include inventory levels, the availability of key staff members, customer recall, product pricing, marketing, sales etc. As an example, if the company is experiencing problems managing inventory, it may be worthwhile to increase the level of inventory and service staff. However, should the dealer’s profitability fall, it would be unwise to increase inventory levels simply to meet delivery levels. Rather than focusing on the short-term factors, it would be more advisable to focus on the long-term factors, such as the ability of the dealer to attract new business and maintain existing customer loyalty.
It is also necessary to consider the cost implications of any short-term investments. This is especially so for businesses that are required to generate cash during a short period of time. One of the key decisions to make is whether to retain existing working capital and/or to take up new working capital. Often the business finance solution will call for the acquisition of working capital over a specified time period, say six months or one year. Again, it is essential to consider the potential costs of the working capital acquisition in the context of the overall business finance picture.
As with all finance decisions, the key issue is to ensure that all risks are understood and that the decision to undertake any activity minimises this risk. This means not only identifying the risks to the business structure but also the likely effects of those risks on cashflow. Much of this can be analysed through the use of a cash flow analysis. In order to successfully implement any form of working capital management, an accurate cash flow projection must be made and this can only be achieved by the establishment of realistic working capital management assumptions.
Once a cash flow forecast for a given period of time has been made, the next step is to identify the funding options available to meet these needs. The most obvious choice would be to borrow funds from external sources. However, where this is not possible or desirable there are other alternatives that may be more appropriate. Among the most commonly used sources of business finance are personal savings, business assets (such as equipment and land), and / or the provision of credit by the suppliers of raw materials. In terms of business assets, the most commonly used assets for business finance are tangible assets (such as plant, buildings and machinery).
Another example of a short term funding solution would be to trade credit. Trade credit is typically based on an agreed credit repayment schedule with a credit limit determined by a pre-agreed balance between the credit amount and the value of the goods or services offered. In theory, trade credit should be a good source of short term finance as it is easy to establish and may also be tradable over longer terms if required. There are many issues to consider in terms of trade credit and the key factors to consider would include:
As with all other forms of financing, it is important to carefully match the type of funding to suit the specific needs of a particular business. It is a good rule of thumb to base a financial decision on the type of business you are in – do not make long term investments that will not prove profitable over the medium or long term. Similarly, do not make large financial decisions that will strain the company’s resources and will have little impact on the business’ day to day activities. Lastly, do not undertake large financial transactions unless you have a sound strategy for achieving your objectives. If you make bad decisions in your business, they will eventually spill over into your personal life and could have a negative impact on your career.
The best way to avoid all these potential problems is to establish a sound business finance management system from the start. A good business finance management system will allow you to determine the cash flow needs of your business, including financing requirements. This will enable you to establish the viability of various short-term and long-term options, such as trade credit and receivables finance. You will then be able to tailor your financing requirements to meet your business needs. Finally, you can enjoy simplified financial operations and avoid potential risks that can affect your finances.