Starting a business is not an easy virtue. An idea is not enough to keep your boat floating. A business requires its every dimension intact, whether its people or team, production, sales, marketing, research and development, accounting, etc. Anyone of them crumbles; your business feels the heat. However, one of the most important (if not most important) element in running your business is the financing of it.
How is your business financed is the real burning question? The mere existence and growth potential rely heavily on the status of finance in the company. Every business requires investment to initiate its presence and activities, and sooner or later (if all goes well), it is also needed to pursue growth and expansion in the market. Another essential element is the mode of finance, i.e., equity or capital. Equity is the investment stake put by owners or shareholders, whereas debt financing is amount loaned by parties for a limited time with interest charged. Debt financing is prevalent among businesses, as it is widely available and comparatively cheaper. Debts are available in various forms and schemes. There are some long term financing like Equipment Loan Financing by Banks etc. and short term financing options like merchant cash advance (MCA) etc.
Let’s explore what are the essential components to consider while opting for financing options for the business.
WHY YOU NEED FINANCING
First and foremost, it is fundamental to ask yourself and evaluate whether even your business needs financing or not. Just because there are many financing options available, funding excessive sometimes leads to significant debacles of firms. There are many reasons why a business requires financing, but there are three broad categories of reasoning:
- Shortage of Cash Flow/ Working Capital
- Equipment Purchase or Inventory Boost for extensive growth
HAVE YOUR FINANCIALS SORTED
It is usually advised by the professionals to have your financial statements set. As some lenders need credibility on the financials prepared. The best way to do it is to get your financial statements audited by independent third-party auditors.
Once finalized that your business needs adequate financing, and it is beneficial for your business, it is usually recommended by experts to check your credit score and credit history. It denotes your credibility and reputation in the eyes of lenders.
One more critical aspect to look out is the “debt-to-equity” ratio of your business. In layman terms, it gives an idea of how much your business relies on debt in comparison to equity. And it’s a basic understanding that the more you depend on debt, the riskier it is for your business. Therefore, to ensure the safety of your business, be mindful of the debt-to-equity ratio.
WHAT’s THE INTEREST RATE
It is not the only but one of the primary elements. Interest Rate determines the cost you will be paying in each period against the loaned amount; therefore, it is wise to compare available loan options against interest rates to determine.
Also, one needs to be heedful even for two or three percentage points in comparison as such trivial would amount to a big difference in loan of longer terms like 10-20 years of financing.
Small loan financing can do in two ways, either you arrange a line of credit with a lender, or you get the whole sum of money altogether. Getting all loan money sounds simple, whereas a line of credit means a business person can disburse any amount within the credit limit set already.
Such modes of arrangement need to be considered carefully according to the requirement of the business; for example, in-time shortage of working capital can be fixed with a line of credit, whereas the purchase of some expensive equipment or machinery can finance through the whole sum of money.
TERMS OF REPAYMENT
Look out for the duration of repayments as such details are miniature printed at the last pages of the loan agreement. When considering any financing arrangement, determine the details of repayments, for example: what is the payment schedule? Is it allowed to pay off the loan early, or it passes the maturity period? Will there be any penalties in case of early payments etc.
TRANSACTION OR APPLICATION FEES
One must be aware that some of the lending firms even charge for the application for loan financing. Some lending firms also charge for the credit report check or appraisal of the collateral. These costs might sound petty, but can be crucial or critical in the overall scheme of financing arrangements.
It is also wise to look out for quality brokers. It can ease the process as they are professionals. To ensure their credibility, experience, and previous client lists should check.
However, if you are confident that you can explore, arrange, and finalize financing deals on your own, you can eliminate this broker or mediators from the transaction. This elimination will save you some essential costs. But one must consider the pros and cons of such intervention.
THE REPUTATION OF LOANING FIRM
The status of the lending firm is also relevant while shopping for loan financing as getting engaged with real professionals can ease up the process, whereas tricky lenders can affect your operations profoundly. Questions like how many years of experience of lenders, any licensing details, etc. can provide enough landscape to gauge their reputation. Also, such information is usually available online on their websites.
YOUR ABILITY TO PAYBACK
Last but not least, your ability to pay back, like any loan financing without repayment plan and strategy, can be a recipe for disaster. Before acquiring any financing arrangement, it is vital to work with numbers thoroughly with every aspect checked, and every possibility worked out. Hence, it usually recommends seeking help from finance professionals while considering the options. And it will also help as a guiding tool while comparing various debt options.
While considering financing options either for starting the business or growing an existing enterprise, one must understand that there are numerous options available at hand, and a detailed understanding of each is beneficial for the long term. So, choose the right choice for you to get the best result.