Unlike what most small business owners think, financing a business is not rocket science. In truth, there are only three major methods to perform it: via debt, equity or what I call "do it yourself" finance.
Every technique has benefits and drawbacks you should understand. At various stages in your business's life cycle, one or more of these methods may be appropriate. That is why, a comprehensive knowledge of each procedure is important if you think you may ever have to get funding for your business.
Debt and Equity: Pros and Cons
Debt and equity accountsreceivablefinance.org are what many people think of when you ask them about business financing. Traditional debt financing is often provided by banks, which loan money that must be repaid with interest within a certain timespan. These loans generally must be secured by collateral in the event they can not be repaid.
The cost of debt is pretty low, especially in today's low-interest-rate atmosphere. However, business loans have become tougher to come by in the current tight credit environment.
Equity financing is provided by investors who receive shares of ownership in the company, rather than interest, in exchange for their money. These are typically venture capitalists, private equity firms and angel investors. Even though equity financing does not have to be repaid like a bank loan does, the cost ultimately can be much more than debt.
This is because each share of ownership you divest to an investor is an ownership share out of your pocket that has an unknown future value. Equity investors often place terms and conditions on financing that can chain owners, and they anticipate a very high rate of return on the companies they invest in.
My absolute favorite kind of financing is the do-it-yourself, or DIY, variety. And one of the best ways to DIY is by utilizing a funding technique called invoice factoring. With invoice discounting products, companies sell their outstanding receivables to a commercial finance company (sometimes referred to as a "factor") at a discount. There are two key benefits of factoring:.
Substantially increased cash flow Rather than standing by to receive payment, the business gets most of the accounts receivable when the invoice is generated. This decrease in the receivables delay can mean the difference between success and failure for companies operating on long cash flow cycles.
Say goodbye to credit analysis, risk or collections The finance company does credit checks on customers and analyzes credit reports to uncover bad risks and set appropriate credit limits essentially becoming the businesss full-time credit manager. It also conducts all the services of a full-fledged accounts receivable (A/R) department, including folding, stuffing, mailing and documenting invoices and payments in an accounting system.
Factoring is not as well-known as debt and equity, but it's often more useful as a business funding resource. One main reason many owners don't consider invoice factoring first is because it takes a while and effort to make invoice factoring work. Many people today are seeking out instantaneous answers and immediate results, but stopgaps are not always accessible or advisable.
Making It Work.
For invoice factoring to work, the business must accomplish one essential detail: deliver a top quality product or service to a creditworthy customer. Of course, this is something the business was created to accomplish anyway, but it functions as a built-in incentive so the business owner does not forget what he or she should be doing anyway.
Once the customer is satisfied, the business will be paid promptly by the factor it doesn't have to wait 30, 60 or 90 days or longer to get payment. The business can then quickly pay its suppliers and reinvest the profits back into the company. It can employ these profits to pay any past-due items, obtain discounts from suppliers or increase sales. These benefits will often more than offset the fees paid to the invoice factoring company.
By factoring, a business can increase its sales, develop strong supplier relationships and strengthen its financial statements. And by relying on the factor's A/R management services, the business owner can work on expanding sales and improving profitability. All of this can come about without increasing debt or diluting equity.
The average business uses factoring companies for about 18 months, which is the period of time it usually takes to accomplish growth objectives, pay off past-due amounts and strengthen the balance sheet. Then the business will likely find themselves in a better position to look for debt and equity opportunities if it still has to.