The process of planning, starting, and running a new business that offers products or service is called entrepreneurship. The people who plan and run these businesses are called entrepreneurs.
Business Financing is the course through which entrepreneurs arrange money for investment for business purposes. Investment can be for starting a new business or for a business already up and running to finance current activity.
There are 3 main purposes of financing:
- Funding a business start-up
- Financing for growth and expansion of a business
- Dealing with unforeseen financial encounters
Sources of Business Financing
- Giving up Equity
Debt is taken by an entrepreneur to use in funding huge purchases that they could not afford under normal circumstances. A debt arrangement means that the borrower is given money under the condition that the money will be paid back at later dates with interest. There are different types of funding:
- Business credit card use
- Small Business Administration loans
- Foreign investors
- Crowdfunding/selling shares of the business
An Entrepreneur Must Be Clear of the Situation and Considerations When Taking Loans
Consider the following when taking a loan:
- How early are the finances needed? If there is no time to wait, then debt financing may be the only option left to invest in the business.
- How much finance is needed? If there is a small amount to be invested, a loan can be taken.
- If a company is running successfully and financing is required urgently, debt can be taken.
- Debt is beneficial if you want to keep the business local and keep the whole ownership with you.
- When taking debt, the lender has no claim to equity in the business. Ownership remains the same. Business operation and bookkeeping decisions remain with the owners/entrepreneurs/executive management.
- When net profit is increased, the lender will only be given the borrowed money and the interest in it. If business progress and rewards are larger, the entrepreneurs will reap the rewards. The lender will have no claim or share in the business rewards/profits.
- Interests on debt can be subtracted on the business’s tax returns: Borrowing money can be a gift to entrepreneurs. The cost of interests decrease taxable profit that your business earns, thus it reduces the tax expense in your company/business. Large corporations/businesses also use this strategy to reduce the tax expense.
Consider options other than taking loans:
- Debt has to be paid back with interests, whether the business is a success or not.
- High interests on debt during a recession of business can dissolve the business.
- The bigger the debt to equity ratio in a business, the more risky the business is considered by investors.
- The company is usually required to place assets of the company as a security/warranty to the lender.
- If you are making day to day purchases and are small in numbers, then the use of a business credit card is the best possible option.
For the starters in the business, it can be a challenging duty of entrepreneurs to decide when and how business financing is right for the business. If the entrepreneur does not have enough money to be used as the capital investment, they may go to lenders for borrowing money or taking debts from banks or financial institutes. Starters in the business field are not experienced and lenders will not give them a true picture. Getting loans in the wrong situations and at the wrong times is costing financial losses to entrepreneurs.
Entrepreneurs must understand these important factors before going to lenders:
- Credit history: previously, how has the business financing been managed.
- Ability to pay back the loan: is the business going well enough to pay back the amount borrowed with interest?
- Has the entrepreneur invested enough personal finances as capital in the business?
- Does the business have assets to be put down as security in debt in the case that the business fails or a period of double dip happens?
- Does the entrepreneur have enough experience in business financing and business operations?
If entrepreneurs are not experienced, they can consult with bankers and accounting firms to get a clear picture of their business and when to take a loan. They can benefit from the advise of bankers as well.Using the right tools and the right assistance at the right time for business financing is a way to a successful business.
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