Factors in Business Financing That Influence Your Decision MakingAbbakin
This post will cover some of the key factors in business financing that influence your decision making as an entrepreneur.
Money makes your business grow. But going to a bank to get it when you have just started in business is not something this article can encourage.
This is because Banks normally give loans to businesses with operating histories and collateral; which most startups business founders do not have.
As pointed out in your previous lesson: Starting a Business 101, every entrepreneur should learn how to start small using personal credits.
We have provided a list of many businesses you can start with little or no money so take the time out to select the kind of business that suits your budgets.
So learn to start small and humbly grow one step at a time!
This is because; most entrepreneurs are having hard times growing up their businesses due to the inaccessibility of business finance or loans.
Most entrepreneurs will definitely answer these two questions:
- How much money do I need to start my business?
- Do I really need to get a loan?
If you are thinking about raising your business funds through getting a bank loan, it is important you understand some common terms that formed the basics of our discussions.
These factors are useful financial terms that can help inform your decisions about financial planning or getting the perfect funding support you would need in the future.
Below are some of the key factors in business financing that influence your decision making as an entrepreneur.
Factors in Business Financing That Influence Your Decision Making
Saving is the income you did not spent, or deferred consumption and this can serve as source of business finance.
Many methods of saving include putting money aside in, for example, a deposit account, a pension account, an investment fund, or as cash.
In business, saving also involves reducing your personal or business overhead and expenditures, such as recurring costs.
A startup entrepreneur who is looking to develop a business must start by saving little amount out of his/her personal credits for some time.
While saving your money in a bank in today’s world of low-interest rates, you need to put your money into the right type of savings account with the best possible rate.
There are several ways of saving your money for the future, but depositing your change in a ‘piggy bank’ is a frequently, and often ignored savings strategy used for startups.
Piggy bank (sometimes penny bank or money box) is the traditional name of a coin container normally used by children to save or store loose change.
#2. Investment Funding
What is investment?
An investment is the purchase of goods that are not consumed today but are used in the future to create wealth.
In other words, an investment is the monetary asset you purchased with the idea that the asset will provide income in the future or will be sold at a higher price for a profit.
Though many businesses can be started with little investment capital; however, if you must start a business; you will need a seed capital – sufficient to maintain a positive cash flow for the business at least the first year.
To invest in a business means to allocate money, time, etc. for the business in the hope of some benefit in the future.
In most financial terms, the benefit from your investment is called a return (the return on investment).
#3. Loan (Debt) Financing
A loan is a debt provided by an entity (organization or individual) to another entity at an interest rate.
Loans are often evidenced by a promissory note which specifies (among other things), the principal amount of money borrowed, the interest rate the lender is charging, and date of repayment.
Usually, you can borrow large amounts with a secured loan, and at a lower rate of interest. And you can also pay back the debt over a long time period, perhaps 10 or 15 years.
As the business owner, secured loans are more risky than unsecured loans because you could lose your collateral if you cannot clear the debt at the stipulated time period.
A secured loan is a loan in which the borrower pledges some asset (e.g. a car, house or land property) as collateral for the loan.
While unsecured loan means that there is no collateral granted for the loan.
Collateral is something pledged as security for repayment of a loan, whether personal, mortgage or business loan, and to be forfeited in the event of a default.
Collateral can be in the form of a property or other asset that a borrower offers as a way for a lender to secure the loan.
If the borrower stops making the promised loan payments, the lender can seize the collateral to recoup its losses.
Most lenders will go through an evaluation of your collateral to determine how much they can lend.
Common types of collateral to expect are:
- your home equity,
- accounts receivable,
- inventory of the business and
- its equipment.
#5. Interest rate
Interest is the charge for the privilege of borrowing money.
Interest can also refer to the amount of ownership a stockholder (investor) has in a company; usually expressed as a percentage.
Two main types of interest that can be applied to business loans:
- simple interest, and
- compound interest.
Simple interest – This is a set rate on the ‘principle’ originally lent to the borrower, which the borrower has to pay for the ability to use the money.
Compound interest – is mainly an interest on both the principle and the compounding interest paid on that loan.
Some of the considerations while calculating the type of interest and the amount a lender will charge a borrower include:
Factor that affect the interest rates
- opportunity cost (the cost of the inability of the lender to use the money lent out),
- the amount of expected economic inflation,
- the risk that the borrower is unable to pay the loan back because of default,
- the length of time that the money is being lent out for,
- the possibility of government intervention on interest rates, and
- the liquidity of the loan being made.
Key variables that determine what kind of loan terms an entrepreneur can get include:
Number of years in business
This is your track operational record and is very important. Most lending institutions or banks usually require three years while others are less stringent.
Size of your company
Though financing institutions varies in the ways they service the public. For example, you would probably not get a personal loan and a large corporate loan at the same place.
But do your research. Ask around. And get to the right spot.
The amount needed
The total amount of money you will need to finance a business is of very important to the lenders. Be sure to specify this based on the projections as detailed in your Business Plan.
It is better to state the amount you will need in the next one year of operation or maximum of three years.
This will allow you the time to try your market and review the business ideas.
Please note that the information about how interests are calculated on loan capital or investments is beyond the scope of this course.
In a future session, you will learn how to forecast future cash requirements through cash flow controls and accounting management systems.