Financing your small business with an outside funding source is perfectly common, but that doesn’t mean you shouldn’t take precautions and educate yourself beforehand. If your business is in a position to take on outside funding, there are several questions you need to ask yourself about cash flow. Whether you’re looking for additional working capital to cover an emergency or finance an opportunity, one fact remains the same: you need to be able to pay back more than you borrowed.
Why Is Small Business Funding Necessary?
Some people wonder why business funding is necessary, why can’t the company save up themselves and finance their own projects without wasting money on interest? While some companies can do this due to low-cost projects or high-profit margins, many businesses have large expenses to cover and spending that much money upfront would strain cash flow.
Business debt is a necessary part of growing the economy. If the economy is not lending, then businesses are not growing. In order to reach the next level in growth, businesses take on loans, credits and funding to help raise their operations and cover initial overhead expenses. Just like college students invest in their career with student debt that will pay off with higher-paying careers, businesses invest in their own projects that will pay off more in the long-term and otherwise would not have been achievable without outside funding.
Here’s how you can make the most of your business funding experience by avoiding common mistakes and ensuring you’re smart about investing.
What Common Mistakes Do Business Owners Make When Using Funding?
The biggest concept you need to understand about lending is that you are paying back more than you borrowed. It is how the lender makes money after providing you with funding. Since you are paying interest or some type of rate for using the money, you need to make sure whatever you are putting money into will generate more than what it costs. This is called a return on investment or ROI. Investing in commercial construction to open up more restaurant seating and serve more guests will allow more profit to be generated; Marketing can attract new customers; A new refrigerator to replace a broken one can keep operations running when the shop would otherwise be closed.
Another common mistake is what’s called getting “overleveraged.” When merchants start “stacking” or taking on funding from multiple funders, they can accumulate more debt than they can pay back. It could happen accidentally when your business is growing through funding and more and more debt is taken on until it’s too much. It can also happen when the first debt is unable to be met, so funding is taken on to pay that debt, then funding is taken on to pay that debt and so on. It’s recommended to stick with one funder and if you find you need more money along the way, talk to them about increasing your amount or receiving additional loans. That way, all of your information and debts are with one company rather than being tied up in several.
Finally, it is important to calculate how daily, weekly or monthly payments will affect your cash flow. While focusing on the project that needs funding, don’t forget about the other aspects of your business that still need money. Normal operations will need to run during the repayment period. Speaking with a financial analyst, accountant or utilizing an in-depth accounting software can help you project cash flow and understand how much debt your business can take on.
What Are The Best Practices For Using Funding?
Finding the smartest way to take on business funding starts before you even get the loan. Before you even apply, you want to make sure your business is as healthy as it can be. You want to apply for funding when you’re strong not struggling because healthier businesses get better rates and terms. When your business poses more of a risk, you’ll end up paying more in interest or factor rates which can cut into your cash flow. What some business owners do is apply for a line of credit before they need it to get favorable terms, then when they do need a cash flow boost they have a source of working capital available.
Seasonal funding is a big reason businesses seek an influx in working capital. The best time to inject additional funds depends on what you’re using the funding for. If you need funding to get summer operations going after the winter, short term funding is best because you can pay it back while incoming revenue is in full swing. If you’re looking to remodel or expand, a long term loan might be best because you’ll want to start construction while business is slow and you can make smaller payments when profits are little to none.
Next, look at your options. Are you zeroed in on a bank loan? While bank loans are known for their comparatively low-interest rates, it might not be the best option for your business. Would your cash flow be best off with high payments for 6-12 months or lower payments for 3-5 years? Is invoice financing or a line of credit going to save you interest because of bad credit or irregular cash flow? Funding comes in many forms, not just loans. Below are some popular options for business funding, but by no means all of them.
What Options Are Available?
The biggest question you need to ask yourself as a business owner is how you are going to fund your business. The method you choose will impact your business for several months to years depending on which route you choose. Think about what you want, and then what you’ll realistically qualify for.
The Small Business Administration provides small business loans that are partially guaranteed by the government. This allows SBA loans to have higher amounts, lower interest rates, and longer repayment terms than bank loans and are often seen as the most coveted form of business funding, however it also makes them the most competitive to qualify for. You will need good credit, strong revenue, several years in business and possibly collateral to qualify.
Bank or Credit Union
You can seek small business funding from a chain bank or a local credit union. These loans are very similarly structured to SBA loans with needing good credit, strong revenue, several years in business and possibly collateral to qualify. A smaller bank might be a better fit for a smaller business and a larger bank might be better for a larger business. If you’re looking for long term funding and don’t need it immediately, bank loans could be your best choice.
Online Lending & Alternative Funding
These options are popular for businesses that need fast cash. Online lenders can transfer funds into a business’s bank account in 1-3 days and usually have an easy online application process as well. Because of the ease with which funding can be provided, alternative funding tends to have higher rates. It’s also a common resource for businesses with low credit to get funding. Some online lenders who provide invoice financing won’t check credit at all because they use incoming invoices as collateral.
Line of Credit
A line of credit provides revolving credit that renews when what you’ve used is paid off. You also only pay interest on what you use, which is enticing to many business owners who have constant yet changing working capital needs. A business line of credit will be able to provide larger credit limits than a regular credit card but may have higher interest as well.
Business Credit Card
Just like with a loan, you need to be smart about using a credit card to fund your business. It can feel like unlimited money but you are still paying back everything you spend plus interest. A business credit card is a popular option for young businesses looking to build their credit so that they can qualify for a bigger funding amount.
There are a lot of questions you should ask before taking funding for your business, but if you choose your funding program wisely and invest the money smartly, you can grow your business and bring growth to your company.
FundKite is one of the fastest growing fintech companies, bringing a unique approach to the long-standing financing industry. Utilizing a boutique funding style, FundKite offers businesses of all sizes, from local small shops to major global firms, a flexible variety of products and services that can be tailored to fit their individual financial situations. FundKite is one of the fastest growing firms in the small business funding industry with up to $2,000,000 in working capital available for funding deals.