Let’s take a look at some of the reasons why business owners will look towards external sources of financing.
- Improve working capital
- Purchase inventory
- Purchase real estate
- Purchase of assets such as equipment
- Expansion of operations
Managing working capital involves managing account receivables and account payables, maintaining a certain level of inventories, as well as making decisions on the investment of available cash. Efficient management of working capital aims to eliminate the risk of illiquidity and maximize profitability and, ultimately, is what keeps a business alive and functioning. Generally, efficient working capital is positively related to cash holding. In the absence of actual cash flow, small businesses may turn towards short-term financing so that they may continue operations. These could be obtaining trade credit with suppliers, applying for an overdraft, or approaching business lenders for a short-term loan to improve the business’s working capital. This could then allow businesses to remain operational long enough to collect cash from customer accounts or make additional sales to repay the borrowed capital and improve cash flow.
Small businesses that experience seasonal demand may look towards short-term bank loans such as a small business loan, as a viable financing option to stock up in inventory. For instance, a retailer of lifestyle goods has noticed that they make most of their sales during the holiday season between November to December. As such, the retailer might strategize to capitalize on this peak in demand by applying for financing to stock up on inventory in advance. After the holiday season has ended, the retailer can use the additional revenue made to repay the bank loan.
You may be keen for your business to purchase property to either expand operations and/or shield your business from unfavorable rental terms. While that is an operationally-sound decision, it would be extremely difficult to run your business without applying for a mortgage. You may be guarding your business against the interest and fees of a mortgage, but there is a hefty opportunity cost. Even if your business has the capital readily available, the large sum of money necessary to make the purchase could potentially compromise your cashflow and impede day-to-day operations. With a long-term bank loan, like a mortgage, company assets may be used as collateral but the business can make monthly or quarterly payments instead of a lump-sum.
The adage of needing to spend money to make money applies here. As your sales increase and your business grow, there will come a time where you need to purchase new assets, such as equipment, to scale up production and expand operations. Similarly to applying for a mortgage to purchase property, you may want to consider applying for an asset purchase loan so that you can spread the cost across months instead of paying up front. Loan terms could vary, from 6 months to 5 years, but the fixed monthly repayments would be helpful to you as a business owner to ensure cash flow in the business and plan your finance. With the additional production capacity from your new equipment and a sufficient amount of time, that equipment could fulfill additional sales and potentially pay for the loan itself.
Expansion of any operational aspect of a business comes with increased cost. From increasing your staff size to renovating a physical space to establishing an online web presence, further business growth does require some form of expansion expenditure. For most small businesses, it is unlikely you would have sufficient cash on hand that is earmarked for investment or expansion purposes. More often than not, the expenditure would have to be taken out of your working capital. In the event that you do see a worthwhile expansion opportunity for your business, do consider the varied business finance options made available by business lenders. For instance, a short-term small business loan would be useful to make payroll for temporary staff during the peak periods. Alternatively, you can consider establishing a line of credit to help finance creative marketing campaigns that will help amplify your business, reach a larger audience, and grow your sales.
Small businesses tend to have low available capital. Instead of sinking your personal savings, the use of financing from external sources can help fulfill your business objectives. Additionally, it will allow you to effectively protect your working capital so that business investments can be made without compromising on day-to-day operations. Do not be afraid to look for business financing as it is a good tool to help build and grow your business. There is a myriad of business finance options in the market and you should spend time to see what is available and best for your business. Given that banks tend to be the business lender that most will go to, we highly encourage you to establish and build a good relationship with them. As always, having a business credit account that makes timely payments is a good way to establish credibility with the bank and access more favorable loan terms.