Knowing
Before You Seek Financing
Preparation and planning
are the keys to starting and running a successful business. That is
especially true in managing the financial end of the business. Before
you consider seeking financing for your business you will need to
determine the following:
- Whether or not you need
financing
- How much of your own
will you have available to invest in your own business
- How much financing is
needed
- What type of financing
is best for the business
- For what, specifically,
you will need the financing
- How you will pay the
money back
Businesses need financing
at various times in their lives. There are three phases in which financing
is usually needed: when the business is being developed, when the
business is getting started, and when the business is seeking to expand.
Financing is usually sought during various phases of the business.
Consider them as three kinds of "money."
- Seed money - money for
research and development before the business begins to sell products
or services. This includes market research, product development
and product testing. Depending on the product or service you intend
to provide, this phase could require a little or a lot of money.
- Start-up money - money
for starting and opening the business. This includes initial equipment
purchases, setting up an office, developing marketing materials
or hooking up phone lines.
- Expansion capital -
money to expand the business through additional products or services,
moving into new market areas (selling to customers you have not
sold to in the past), adding additional employees or adding equipment
to handle an increase in business.
When approaching a bank
for a business loan, or an investor for capital, you need to be prepared.
This means having cash flow projections that are reliable and that
can be justified by research or the business's history. It means financial
statements that are comprehensive and accurate. If you have a completed
business plan, it will serve as the basis for your presentation as
well as the basis for the bank's decision. If you do not have a business
plan, now is the time to develop one. Your plan should include a complete
description of the business, including products or services, marketing
and management strategies and up-to-date financial information. (Refer
to folder "Here's The Plan," for assistance in developing a business
plan.)
Financial information in
your business plan should include:
- Summary of financial
needs
- An outline indicating
why you are applying for a loan and how much you need.
- Sources and uses of
funds statement - It is important that you explain how you intend
to spend the loan funds and how it will aid the business.
- Cash flow statement
(budget) - A statement projecting what your business plan means
in terms of dollars. It shows how money comes in and out of your
business; amounts, sources, and recipients.
- Income projections -
This statement indicates the income and expenses you are projecting
for the next three years. Use your cash flow statement for the first
year and project the next two years based on trends and your business
plan.
- Break-even analysis
- The break-even point is when the company's expenses are matched
by the revenue. It is shown in total revenues matched with expenses.
Graphics are often used to express the break-even analysis.
If you have been in business
awhile, or if you have purchased an existing business, you should
also include this financial information with your business plan:
- Balance sheet - A report
showing the financial condition of your business. The balance sheet
lists all of the assets of the business and all of the liabilities.
The difference between the value of the assets and the amount of
the liabilities is the net worth.
- Income statement - Sometimes
called the P & L (profit and loss) statement, it shows the financial
activity for a period of time (monthly, annually). It is a changing
picture, showing what is happening financially in your business.
- Business financial history
- A summary of financial information about your company from its
start to the present. Graphs are excellent ways to show multiple
years of income and expenses.
Stand behind
the figures
Make certain that you can
support your financial data and projections with facts and outlined
plans. Your relationship with your banker or investor is an important
one. He or she should be treated with integrity and honesty. Inflating
projections or using the loaned money for things other than what you
have stated will damage your relationship and will jeopardize your
loan status.
There's more...
In addition to financial
data such as the statements and plans you provide to the banker, be
prepared to answer additional questions. For example:
- What are you going to
do with the money?
- Are you going to purchase
new assets such as equipment, real estate or machinery? Pay off
old debts, substitute new debt for equity? Or pay for expenses needed
to create new revenue.
- Why is this loan good
for your business?
- When will you pay the
loan back?
Investors or bankers are
interested in investing money in ways that will help the business
grow and be profitable. Sometimes people regard bankers as heartless
money machines. Bankers want their business to be productive and profitable
the same way you want yours to be. Lending money is their job. They
are looking for good loans, but they want some assurances of return.
Be prepared to go into detail about what their money will do for your
business and why you believe it is a good risk.
Your cash flow projections
will indicate the time it will take to pay back the loan with interest.
The length of time it will take you to pay back the money will help
to determine what kind of a loan you are seeking. Loans have to be
paid off at predetermined times. Investors who provide money for equity
(ownership) in the business, often take the risk of a longer pay-back
time on the initial investment with the hopes of a higher return.
What happens
if your plans don't work out?
This is what is called
collateral. Sometimes banks require an abundance of collateral. Depending
on the financial situation of the business, you may be requested to
give a personal guarantee (putting personal assets up as collateral)
in order to get the loan. Bankers are in the business of warding off
risk. This makes them inevitably skeptical.
You should develop a back-up
plan for paying back a loan if your plans do not work out before you
seek your loan. Anticipate detours in your business plan. Think through
and document what you will do if a product or service does not sell
the way you thought it would, or if the raw materials or supplies
you use suddenly increase in price.
How much money
are you putting into the business?
It sounds ironic, but you
have to have money to borrow money. A bank will expect you to invest
some of your own money into the business. Some entrepreneurs make
the mistake of spending all of their available cash first and then
go out to seek additional financing. It is better to lay out a plan
which projects how much money you will need for the business to generate
its own cash, then use your money to fund a part and borrowed money
to fund a part. Most banks or financing programs will not fund one
hundred percent of the needed money. Therefore, your available funds
should be used to fund a portion of the overall needed financing.
Most banks and financing programs require twenty to fifty percent
of the needed money to come from you. Some special programs, such
as the MicroLoan program, may only require ten percent of your own
money depending on the situation. This type of financing is unusual.
Equity investors are people
who invest money in the business in return for part of the ownership.
Your portion of the investment may be your work and efforts. In other
words, you do the work and they provide the capital to help make the
business grow.
Next Chapter...
