Things to Consider When Financing Your New Business
From support to choosing the right amount, we look at key measures to take before you go after finance
When embarking on a new venture, it is imperative that you carefully consider the most appropriate and robust financing model for your chosen business. The right financing package will carry you through any temporary difficulties, while allowing you to make the most of growth opportunities as they arise. So when it comes to finance, where should you start?
It is important to get the right type and mix of finance for your business. Having finance available is an asset, and like any asset you use you should utilise it. If it is not in use it’s a cost with no benefit so you should change the type and mix.
When looking at the best mix of finance available, it is vital to consider the cost of finance with the help of an accountant.
Deciding how much you need
The first and arguably most important step is deciding how much money you will need. This means working with your accountant or financial adviser to draw up a detailed business plan.
Research shows that only one in three businesses have a business plan. Even fewer regularly use those plans and for many it is a static document which is only used when finance is needed. However, when used successfully, a business plan will reduce costs, identify opportunities, minimise risks and help the business to succeed.
Areas which should be addressed in a business plan include:
- About your business
- Market/Competitor analysis
- Marketing and sales
- Your operations
- Financial forecasts
- Financial requirements
When starting a business, it is easy to be over-optimistic, but it’s imperative to ensure that the forecast is as realistic as possible. This is often the downfall of many start-ups – sales turn out to be lower and take longer than expected, getting paid takes longer and costs are higher – and the correct funding is not in place to support you during these tough times.
You will also need to consider how much financing you require and when you’ll need it. Certain industries will go through peaks and troughs with seasonal sales patterns. For example, a toy manufacturer faces heavy raw material costs in the summer — producing a large stock of toys — but may not receive cash from sales until after Christmas. At the same time, you should allow for contingency funding, as you never know how much extra finance you might need. Having as accurate a forecast as possible is key here.
Borrowing from the bank
After your own savings, the most likely source of financing is the bank, who will work through your business plan and forecast with you in detail before agreeing to provide any level of financial support. Before your initial meeting, make sure you have considered how much you need to borrow and what you can realistically afford.
In the short-term, many businesses need access to overdraft facilities from time to time. Overdrafts are useful for financing temporary or fluctuating cash shortages. However, remember that exceeding your overdraft limit is costly. The bank may return payments, damaging your credit with suppliers. You can also incur material bank charges and higher interest rates – so make sure you manage your overdraft closely. It is also to consider, during the planning stages, whether an overdraft is the best ‘asset’ for your business. If you only use it once a year it could be the most expensive option.
For longer term needs, business loans are often the best option. Most loans are for a fixed period of between one to 10 years, while mortgages and some other loans may be for as long as 25 years. Paying equal monthly instalments of capital plus interest is a common choice and you may be able to arrange a repayment holiday to allow time for your cash flow to pick up before the first repayment is due.
While borrowing money from the bank is the most common path for those starting up a business, you will also need to be able to point to an adequate amount of money already invested in the business. That could be capital that already exists – in the form of cash or investment opportunities, or perhaps taking a mortgage on a personal property and then “lending” that money to the business. Another less common avenue is crowd-funding — financing from a group of investors who get together and each contribute a small amount of funding.
Other sources of financial support
In some cases, trade credit, where you negotiate to pay your suppliers in arrears of receiving the product or service may be all that new business needs. Suppliers keen to enter a new market may offer extended credit to customers, but there are other options worth considering.
An example of this is hire purchase (HP), often used to finance the purchase of equipment. In essence, you buy the equipment, but payments of capital and interest are spread over a fixed period — usually three to five years. Furthermore, you can claim capital allowances on the equipment and the interest payments receive full tax relief.
It is also worth looking into whether a range of other financial support options could be suitable for your business, such as barter, business angels, and business credit cards, even friends and family, grants, overdrafts, peer to peer finance as well as trade loans.
This article was written by Sarah Hathaway, head of ACCA (Association of Chartered Certified Accountants) UK