All businesses require funding. Indeed, even the smallest, one-person operation will have some startup costs. So, initial capital investment will be required. And for larger businesses, seed funding, third-party investment, or a bank loan may be necessary.
Then, as a company grows, financing may be needed to purchase new equipment, open new offices, or launch new products. Meanwhile, working capital will be required to fund the day-day-day operations of the company.
So, the need for business financing is unquestionable. And there are numerous ways that a business can be funded. However, there are also numerous pitfalls that a company can stumble into when borrowing money too. Here are some of the typical business financing mistakes that are best avoided.
Borrowing too much money can leave you with unaffordable repayments. And you will be paying interest on funds that you are unable to put to good use. So, borrowing as much as a lender is willing to offer is not always the best approach. Borrowing too much will also impact your credit rating and limit your ability to gain finance later.
It is also possible to underestimate your cash requirements and borrow too little. In this situation, you will find yourself needing to reapply for further funding later. And gaining approval for bank funding can take a longtime. So you might be left with a significant cash flow shortage while you arrange alternative financing.
When you apply for financing, the decision will be based on the forecasts you provide, the credit score of your business, and historical results. But, you might be tempted to inflate or overestimate sales forecasts to increase the amount the lender will lend. However, if you borrow more than you can realistically afford, it could put your business at risk.
The various financing products are designed for different purposes. Long-term loans, for example, are best suited for the financing of fixed assets, like buildings and machinery. Credit lines, such as overdraft facilities, are designed as a short-term financing option to help with day-to-day working capital needs. And business credit cards are intended to be used for small-value purchases that will be repaid at the end of the month.
The interest rates for the various types of financing reflect the expected usage of the funds. Maintaining a high balance on a business credit card, for example, would be expensive compared to other types of loans. And having a continuous high overdraft would be far more costly than a long-term repayment loan.
Sometimes, financing is not the best solution. It would be a mistake, for example, to borrow when a cost-cutting exercise would be a better solution. If you borrow for the wrong reasons, the underlying issue will only rear its head again several months down the line. But then, when the problem reoccurs, you will also have the loan repayments to meet.
Borrowing should bring a net benefit to the business. For example, suppose you borrowed to purchase new equipment. In that case, that increased profit generated by that piece of equipment should exceed the cost of borrowing. So, it is advisable to complete a cost-benefit analysis when considering your financing options.
A mentioned above, there are many different financing options available for businesses. And some of these options might provide better value for money than a straightforward business loan.
If you wanted to acquire vehicles, contract hire would be an option you could consider. Contract hire agreements usually include vehicle maintenance costs. And, when the contract ends, you can return the vehicle or swap it for anew one with no further capital outlay. So, overall, contract hire could be a cheaper and more straightforward way of financing vehicles.
Likewise, sales invoice financing, or factoring, could be an alternative to a loan or credit line. Invoice factoring is flexible, provides fast access to working capital, is comparable in cost to other types of borrowing, and does not appear on the balance sheet as a loan. Most factoring arrangements also include accounts receivable management services too, which will reduce administration costs.
So, to sum up, it is advisable to consider all your options before entering into any financing agreement. It is also best to complete a cost-benefit analysis of the various forms of financing before reaching a decision. And run the figures through a spreadsheet to ensure that loans are affordable, even in a worst-case scenario.