In contrast to what most small business owners believe, financing a business is not brain surgery. As a matter of fact, there are only three primary ways to perform it: via debt, equity or what I call "do it yourself" financing.
Each and every technique has benefits and drawbacks you should take note of. At various stages in your business's life cycle, one or more of these methods may be appropriate. Therefore, a comprehensive understanding of each approach is crucial if you think you may ever need to secure funding for your business.
Debt and Equity: Pros and Cons
Debt and equity are what lot of people think of when you ask them about business financing. Traditional debt financing is typically provided by banks, which loan money that must be repaid with interest within a certain time frame. These loans generally must be secured by collateral in case they can not be repaid.
The cost of debt is fairly low, particularly 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, as opposed to interest, in exchange for their money. These are typically venture capitalists, private equity firms and angel investors. Although equity financing does accountsreceivablefinance.org/ not have to be repaid like a bank loan does, the cost in the long run might be much higher 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 funding that can chain owners, and they expect 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 using a financing technique called invoice discounting. With factoring 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:.
Considerably improved cash flow As opposed to waiting to get payment, the business gets most of the accounts receivable when the invoice is created. This reduction in the receivables lag can mean the difference between success and failure for companies operating on long cash flow cycles.
No more credit analysis, risk or collections The finance company conducts 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 widely known as debt and equity, but it's often more helpful as a business funding tool. One reason many owners don't consider invoice factoring first is because it takes a while and effort to make invoice discounting work. Lot of people today are seeking immediate answers and immediate results, but quick fixes are not always readily available or advisable.
Getting it to Work.
For invoice discounting to work, the business must achieve one very important thing: provide a quality product or service to a creditworthy customer. Obviously, this is something the business was created to accomplish to begin with, but it serves 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 factoring company it doesn't need to wait 30, 60 or 90 days or longer to get payment. The business can then without delay pay its suppliers and reinvest the profits back into the company. It can use these profits to pay any past-due items, obtain discounts from suppliers or increase sales. These benefits will normally more than offset the fees paid to the factor.
By invoice factoring, a business can boost its sales, establish strong supplier relationships and strengthen its financial statements. And by relying upon the factor's A/R management products, the business owner can concentrate on increasing sales and boosting profitability. All this can come about without increasing debt or diluting equity.
The typical business uses a factoring company for about 18 months, which is the time it usually requires to attain growth objectives, pay off past-due amounts and boost the balance sheet. Then the business will likely be in a better position to pursue debt and equity opportunities if it still needs to.