Small Business Finance Guide – Part 1

To succeed business needs to have a committed owner, a viable business concept and strategy, and sufficient capital to help the business grow and thrive. The easiest approach to financing is using your own money, but may not be an option. Alternately  you may need to obtain financing or capital from friends and family, a bank, or other sources. Whatever the source, financing can be categorized into two options: debt and equity financing.

Assessing Your Financing Needs

A first step in determining how much money you will need to start this business is to begin with start up costs. Although some businesses are started with minimal capital, others require a large initial investment to purchase real estate, inventory or equipment. You will also need money to maintain your household, these funds should keep that separate from capital you use for starting your business. To determine how much you need:

Calculate Start Up Costs

 

One-time charges

 Including signage, business name registration, incorporation fees.

Recurring costs

Including fixed expenses like rent, utilities, insurance, payroll and variable expenses such as inventory, shipping, & sales commissions.

Hidden costs

Be prepared for unanticipated expenses that were not included in your plan. There should be approximately 10% in contingency money for these costs. This is dependent of course on the accuracy of your projections.

Personal Financial Statement

The first question any financial institution asks is how much personal equity you will bring to the business. The amount of personal equity lending institutions require varies depending on many factors. The SBA calls this a Statement 413, and the expectation of any lender is that this document be completed fully and accurately so a proper assessment can be made.

Calculate Your Monthly Expenses

It’s important to estimate your expenses as closely as possible by building accurate monthly cash flow projections. Asking for more money than you actually need jeopardizes your ability to secure a loan and will make your debt service higher.

If you are expanding an existing business, you will need to be able to show your business is profitable to be eligible for financing and what the capital infusion will change. If applying for funds due to financial difficulties, you will most likely need collateral to secure any type of loan.

A Word On Free Cash Flow

 Free cash flow is an important concept in any business. It is used by all types of financing sources from equity investors to lenders. It is also critically important for determining the value of the business when buying and selling. Essentially free cash flow is a measure of how self supporting a business is, how much cash a business generates. That may seem to simply to be the net income from a business, however it is important to extract depreciation from your net income figures and as the business becomes more sophisticated break cash flow out between operations and investing activities. We will go into some detail later but if you are selling your business it is absolutely critical to show an increase in free cash flow month over month because when the Net Present Value calculation is applied to your figures that will increase the end result, the value of the business. The reverse is true with buying a business. It is a definite advantage to have the free cash flow reducing month to month or year to year as this trend quickly lowers the established value of the business.

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