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Understanding Small Business Finance

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Small Business Finance is a growing area of specialized financing that has been growing in popularity ever since the passage of the SMART Act. Many small business owners have not even heard the term, much less understand what it means. Small Business Finance, in essence, is the lifeline of most modern businesses; without it, they would fail and be swallowed up by their slower, more expensive competitors. Small Business Finance was designed to address the unique financing needs of small businesses and their owners through a variety of tools and policies designed specifically for them. Small Business Finance is an often complex and misunderstood field. On this web site, we'll take a brief look at some of the basic definitions, as well as some of the resources and tools that you can utilize to learn more about small business financing.


Small Business Finance is a subset of accounting terms used to describe the specialized methods and practices utilized to manage small business loans, lines of credit, investment capital, and other forms of financing. The acronym SMART refers to specific characteristics of small business financing, which vary according to the nature of the loans (e.g., commercial real estate loans versus personal loans). Small Business Finance is often divided into two major subsets: management and credit. Although the two overlap somewhat (credit is part of the larger field of small business financing), each is on its own distinct path.


In its simplest form, small business finance revolves around two types of debt financing: capital and equity. Most commonly, small business owners seek debt financing to bridge the gap between starting assets and starting operations costs. Often this type of financing is referred to as start-up debt. This financing is based on future earnings that will hopefully be realized through product sales or service revenue. Some start-up businesses rely on short-term loans that are repaid when the product or service has been sold.


Equity financing is a means of obtaining funds from an existing financial institution in exchange for shares of ownership in that organization. Small business finance businesses may also seek equity financing from other investors, banks, or other enterprises. Equity financing is most often obtained from angel investors (investors that offer funding not only to start ups but also to mature businesses) or from venture capitalists (private individuals who contribute money to a company to generate a profit). Small business finance businesses may also sell their ownership interests in a business in exchange for a portion of the profits that would result if that business were to sell for one year. Venture capitalists usually provide seed money to new companies as it relates to building the equity in that company.


One form of financing used by small business finance businesses is a cash flow projection. In a cash flow projection, a small business finance business agrees to repay a loan based on the current cash position of the company. To do this, the business must estimate its gross sales, its inventory levels, its cost of goods sold, its gross and net operating expenses, its net working capital and its net debt as of the last 30 days. The result of this process is a projection of cash flows that will help lenders determine if they will issue a loan. The result is helpful because it allows the business owner to plan for future expenses based on the information provided in this process.


Another important factor for small business finance companies is their ability to understand and use accounting terms. Most lenders require that finance companies have a comprehensive understanding of the concepts that affect the loan and creditability of a business. By understanding and applying these accounting terms, the finance company is able to better understand the risk inherent in borrowing funds and therefore control the risks associated with its borrowing.

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