Do you want to start a business but you are short on cash? Have you been making plans towards hustle but there is not enough money available to finance it?
Business finance is often said to be one of the core points one should take very seriously. It deals with how individuals and organization can generate funds and how such funds can be used effectively.
The words, “used effectively” comes with a very strong approach, that is, how to spend it in a prudent manner in order to achieve the purpose upon which the organization is created.
There are certain factors that determine choice of finance, for instance, It is unideal to use long term finance to execute a short term project or vice versa, this article will attempt to place each source of finance in its own category.
Financing of business is just one part of decisions when running a business. There are always questions about how to meet the day to activities or expenses.
How about the evaluation of business to determine which of them will come with lesser risk and may increase the profit of an organization.
If it is a big company, added to it is how the net profit will be apportioned to shareholders and retention within the company.
For a side hustle, you may not have much to do aside knowing how to raise money for the business, warehousing, and how to sell it. If managed correctly, it may elevate into a big investment. With big projects come additional finance.
Now that we have been able to look briefly at the other part of business planning, let’s look at the benefits of business finance.
Benefits of business finance
A regular supply of funds
Business finance ensures adequate and regular funds to other sections of the business. It ensures personnel, production team, marketing, maintenance, and other departments in an organization have enough money to carry out their day to day activities.
To maintain cordial relationship between borrowers and lenders.
The relationship between a lender and borrower can get toxic when borrowers refuse to pay money as at when due. This could lower credit score which would eventually be one of the deciding factors when one seeks a loan in the future.
Business finance will help to enhance the repayment of loans, both the initial amount and interest can be financed at the due time and thereby bonding the good relationship between the individuals and the lenders.
Helps in choosing the right project the available fund can finance
It is not bad if one has a big dream but executing it will depend on the funds that are made available.
Business finance helps in making a decision on which investment project to go for, thereby analyzing the cost and expected income and which in doubt put the business into the path towards achieving its main goal, which is profits making.
It helps to answer important questions
There are certain questions that will need some answers when an individual or organization wants to start a business.
Questions like where they can source for finance to meet its day to day activities and long term objectives, what project should one embarked upon, that is lines of businesses should one invest in, how to manage daily activities such as payment to suppliers, delivery to customers or clients expenses and other administrative costs.
How to procure and protect assets used by business for production purposes and avoiding excessive keeping of assets and inadequacy are also questions that business finance provider answers to.
How Individual source finance for their business.
To meet the day to day activities and to meet their current and capital obligation like raw materials purchase, acquisition of fixed assets, payments of salaries or wages if there are, and payment of interest and dividends, the organization will need to source for the fund and look for the appropriate one.
Sources of business finance can be grouped into three based on their maturity – Short term, medium term, and long term finance
Short term finance
These are funds that are released from loan providers or finance companies to borrowers for a short period of time, it may be for a period of 3 months, 6 months if 1 year.
Aside from borrowing from banks, there are other ways to source finance for short term business which will be discussed under this thread.
Sources of short term finance
This occurs when the supplier grants credit to their customers which is payable in later days.
Trade credit is commonly used by customers who had already have a long term and strong relationship with the suppliers and enjoyed by customers due to the fact that it accumulates no interest when compared to some sources of finance like overdrafts and loans.
Before such will be granted, the suppliers always make sure that beneficiaries are creditworthy, that is they can be relied on to pay at a specified period of time.
This is another way that individuals and organization source for funds, which is provided by banks to customers that operate current account.
Banks allow customers to withdraw more than what they have on their account. This type of fund is commonly used to finance current assets such as the purchase of raw materials and taking care of some emergency needs.
This is a mutual agreement between the company and factor, this arrangement usually occurs when the company or business is in need of cash or want to avoid tying down capital.
The factor will undertake the debts of the company if it is less risky, although there are times when factor may refuse to manage all the debts of the companies if it considers them to be too risky.
The major function of a factor is to help firms with enough cash for the successful running of the business on a daily basis. Keeping sales ledger account, collection of debts as at when due from debtors and insures the clients against loses from bad debts and other activities carried out by factor.
The major setback of factoring is higher interest rate charged and commission for agreeing to be responsible for the business.
These are revenue received from customers for supplying goods or services in the later period. These earnings are received by companies with an agreement to supply goods and services later.
This is also a source of finance for any establishment as the receipt of income at that period will increase the company’s liquidity which can be used to meet the firm’s obligation towards positioning itself as one of the household name companies.
Although I pointed it out as revenue, when such payment is made, the firm will not enter into the record as revenue until it meets the customers’ demand which is delivering of goods or services.
This is another business finance used by individuals and firms to meet their obligation. Accrued expenses will occur when some expenses are not taken care of, like when wages and salaries are not paid, interest retained or when there are accrued taxes. All these funds can be diverted into the business until it starts producing profits.
Refusal to make payments will enhance the liquidity position of the firm and there won’t need to pay interest. Although the danger is that it might ruin the reputation of the company especially when workers protest in the public and actions by the tax authority.
This is usually given to companies with remarkable creditworthiness, commercial notes are issued out by issuing house on behalf of the bank, those notes would be purchased by investors in the money market.
Commercial paper comes with a charge which is called coupon rate and the commission paid to the issuing house on the amount raised.
Short term loans
These are loans provided by finance companies, local borrowers or commercial banks for a period not more than a year.
The old method is to walk to the bank, meet the customer care agent, fill the form and other requests as needed by banks. Banks now grant loans to salaried workers and small business owners with no collateral and without the need to visit banks for documentation. With the advancement in technology, all can be done using your smartphone.
Kwikmoney loan also provides you with a very quick access. No app installation, just dial *561# on any mobile phone and you are good to go.
We have seen lots of finance companies coming out with credit products, mostly called instant loan. These loan providers give personal loan to qualified people for not more than 12 months, example are palmcredit loan, branch loan, credit direct, zedvance loan, renmoney loan and several others
Medium term finance
These sources of finance are in between short and long term finance, they usually range from 1 year to 10 years.
Short term finance can only help a firm to a certain limit, as firm grows, the working capital may be insufficient to carry out the day to day activities, therefore the need to find business finance with more than a year tenor.
The major suppliers of medium term finance are commercial banks, merchant banks, development banks, mortgage banks, and other financial institutions.
Sources of medium term finance
These are loans granted by banks especially merchant banks and development banks for more than a year.
It is almost similar to short term loans except that short term loans are mostly provided by banks and other financial institutions while term loans are provided by merchant banks by merchant and development bank with tenor between 3 to 12 years.
Standard chartered loan is a good example of medium term loan. It grants loans to deserving individuals or companies for a repayment period of 5 years.
Repayments are usually made on a monthly basis which is expected to go until all outstanding amounts including managerial fees, principal and interest are paid. It normally carries a higher interest rate because of the long repayment period.
Since it has a reasonable amount of time for repayment, such can be used to finance permanent increase in working capital and also used to acquire assets like vehicles, equipment, and machineries.
Leasing is a binding agreement between the owner of the asset and the user of the asset where the owner transfers the right to make use of an asset to the user of the asset for an agreed period of time and in return for a consideration usually periodic payment called rents.
The owner of the asset is usually called lessor while the user of the asset is called lessee. Payment will be made to the lessor regularly after an agreement has been reached by both. The parties can agree on a monthly, quarterly, half-yearly or yearly basis.
The lessor may be a company which specializes in leasing, commercial banks, finance houses, merchant banks or an equipment manufacturing company,
Another way businesses use to get finance is through hire purchase, a firm with limited capital can decide to acquire fixed assets like machinery, vehicle, and equipment while payments are made on an installment basis.
The installment basis which is expected to last for years will cover the cost of the assets and interest charged on the asset. This type of finances helps businesses to acquire and use an asset without committing huge cash to the project. Do note that ownership does not pass to the hiree (hire purchaser) until all installment payments are received. Failure to make payment on a regular basis could lead to the hirer retrieving the asset.
Long term finance
Long term finance is another source of finance whose repayment period is usually extending beyond 10 years.
Big companies like banks, MTN, 9mobile, and Top food outlets will prefer to use long term finance to execute long term projects when going through financial difficulties.
Sources of long term finance
These are contributions by shareholders who are the legal owners of the company, it is otherwise called Equity. Ordinary shares represent the ownership position in the company.
A share certificate will be issued to the shareholders immediately after the capital has been received. The legal owners of the company can now participate in some functions as ascribed to the shareholders’ such functions may include selecting directors whose one of the job descriptions is to employ personnel to help in the running of the affairs of the establishment.
The shareholders will be entitled to dividends declared by the company after the company had paid interest on debentures and dividends of preference. In the event of winding up, the shareholders have right on residual claim on the assets of the company.
This form of source of finance bears both the features of the ordinary share capital and debenture.
Preference share is a share which entitles shareowner to a fixed dividend, preference shareholders have claims on income and assets of the company prior to ordinary shareholders even if the company enters bankruptcy.
Retained earnings is another way to get funds for businesses. Management may decide to use the portion of net profit which is expected to be distributed to the shareholders for business purposes.
It is common with large firms to use unshared profits to start another project which might open another stream of profit to the company. Most managers and directors of multinational companies always try to negotiate their way with the shareholders to leave a certain part of their dividends for reinvestment.
The argument for retained earnings is that it is an interest-free source of finance and bear no issuing fee.
Debenture is a document issued by a company acknowledging indebtedness. The document acknowledges a loan to a company which usually contains the payment modes, repayment of the actual amount and the interest.
This type of business finance automatically makes debenture holders as creditors of the company and not part owners as the ordinary shareholders.
The debenture, unlike ordinary shares which pay dividends to shareholders out of the proceeds of the company, debenture interest is paid to the holders whether profits are made or not.
Debenture holders take priority over ordinary and preference shareholders whenever payments are to be made, even in the event of insolvency, the debenture holders are entitled to proceeds even before the ordinary and preference shareholders.
Depending on the project, there are always available ways to get finance for your business. The danger of going for sources of finance with interest charged is that it will reduce the expected profit of the business and also ruin image if payment is not made or paid in time. It can also damage your credit score and accumulate late fees.
For small business owners, money borrowed from family or friends always come with no charge, that is no management fee or interest, such money can also be used to start or improve your business.
Top companies will need to go for what is best for them but will need to be careful of traps set by financial institutions. Ensure the interest rate charged on the principal is what you can afford to pay, always negotiate your way to get the best loan services for your business. If you are not okay with the charges, you can always look for other alternatives.