Business finance is one of the fundamental pillars on which an enterprise is built, managed and grown. Most functions within a business require strong financial backing for their day-to-day activities as well as long-term planning.
Start-ups and small businesses often face the brunt of improper management of finances in their initial years, eventually failing to take off and shutting down as a result.
According to the survey carried out among start-up owners worldwide, the main reasons why their businesses did not work out were running out of funds (38 per cent).
Therefore, business finance needs to be prioritised well to solve for risks and capture the right opportunities.
This article explains the types of business finance, throws light on the key planning elements and shares 5 tips to systematically manage it.
What is business finance?
| The concept of business finance revolves around the acquisition and management of funds to efficiently run an enterprise. It deals with systematic estimation, deployment and application of capital by the company’s finance teams. |
Features of business finance encompass several steps such as forecasting, planning, regulating and discharging funds for the various functions of a business. It is a critical component that determines the scale and size that a business is able to achieve.
Very few businesses are built on a self-sustaining model and entrepreneurs need to consistently secure funds as well as plan them carefully through their finance strategies. The capital required by a business can be broadly divided into 4 categories:
Fixed capital: Money required usually at the start of a business for fixed assets including land, infrastructure, machinery, etc
Working capital: Money needed for daily functioning such as raw materials, rent, salaries, taxes and so on
Diversification: Funds used by a company to expand/diversify itself by adding new products and offerings to its portfolio
Technology: Capital that is invested in upgrading or switching to better technological solutions
Types of Business Finance
There are several ways to finance a business, here’s a look at the most popularly adopted methods.
Debt financing
In debt financing, a company raises funds through instruments such as bank loans or bonds. Private investors can also be involved in debt financing but is not a very common practice.
In simpler words, a business borrows money to pay it back after a certain period along with the interest amount.
Debt financing is usually preferred by well-established firms that are confident of timely payoffs due to their continuous sales, long-standing business processes and profitability. New businesses may lack the confidence to opt for this method owing to the limited risk-taking ability in the initial years.
Banks often check the personal credit history of new enterprises and follow due diligence and other verifications for more mature businesses while sanctioning loans.
| Advantages | Disadvantages |
| No lender control over your business | Maintaining a good credit rating is mandatory |
| Interest paid is deducted from income for tax calculation, reducing the overall tax | Can be impacted heavily during recessions |
| Fixed loan amount helps in better planning of repayment | Businesses may have to pay high interest rates |
Equity financing
Equity financing which is commonly pursued by startups involves offering a stake in the business in return for an investment/funding. Equity doesn’t demand repayment of the funds since the investors buy shares in the company and earn returns through dividends or by selling the shares at a later stage.
Investors can either be venture capitalists or angel investors. A venture capitalist is a firm that infuses a sizable capital in the business with complex deals. They consist of a team of partners, lawyers, accountants, and advisors and follow strict due diligence before any investment.
Angel investors are individuals who are capable of investing money to support businesses during their initial stages. The amount is relatively smaller and the terms simpler.
The capital gains by investors are highly dependent on the success of the business and hence they are often involved in supporting the business in its long-term objectives and goals.
| Advantages | Disadvantages |
| Capital stays perpetually with the business, without an obligation to pay dividends | Raising funds is a lengthy and complex process, requiring continuous efforts |
| No credit rating-related issues while raising money | Lack of complete control can lead to interferences in management |
| Network and knowledge of investors help entrepreneurs with valuable insights | Business profit will have to be shared with investors |
Mezzanine Capital
Mezzanine capital combines a bit of both equity and debt financing and allows the lending entity to convert a loan into equity in case the business fails to repay it in the specified time.
The returns are high which means the interest rates are significant and hence it is usually chosen by well-accomplished businesses.
Companies that opt for Mezzanine financing are likely to have exhausted the borrowing limits or have blocked certain funds for future needs. Businesses may decide on this method to fulfil initiatives such as acquisitions, expansions, diversification and so on.
| Advantages | Disadvantages |
| A more flexible structure than equity or debt | Need a long and established company track record to qualify |
| A cheaper option for securing finance than equity | Consistent profitability is necessary in most cases |
| May not require a change in ownership if the debt is paid in time | May include warrants who can demand higher returns |
Also Read: 9 Key Steps to Help You Start an Online Business
5 essential tips to manage business finance
If you are a small business owner, here are some 5 tips to efficiently manage your finances.
1. Focus on growth: It is recommended to allot a sizable amount of funds specifically for growth-related opportunities. This will also help the business draw a plan for its future that is supported by financial backing.
2. Don’t let loans worry you: Loans can seem daunting due to the financial risks attached to them. However, with a sound business finance plan, loans can help you drive important decisions necessary for the company’s growth. When used with careful estimation, they can improve cash flows as well.
3. Retain good business credit scores: Maintaining a credit score makes it easier to qualify for a loan. It is also helpful for securing competitive interest rates and even extending the credit limit in some cases.
4. Balance expenditures and ROI: Cash burn is not uncommon in the current startup ecosystem. A good practice is to focus on both spends and ROI simultaneously so that your finances do not take a hit in the near future. Cutting back on excessive expenses and directing them towards new initiatives is a good way to balance the two.
5. Maintain good financial practices: Better internal control of your finances shall help you largely avoid risk and fraud. A dedicated team and time to regularly update and review your finance plans can lead to well-grounded financial health for the business.
Working on a business finance plan: Key components
A detailed plan is crucial to ensure that the business is well aware of its financial status and aligns it with the goals. Here’s a broad list of the key elements a finance plan should cover.
Strategy: Begin with the goal that you have thought of for your company and draw a plan that details out everything that is needed to reach the goal. Listing all the requirements whether it is an office space, tech tools, or resources, will help you achieve clarity on the financial support needed to start and sustain the journey.
Financial projections: Based on the strategy, predict the expenses to meet your earlier specified goal. This should include the overall costs, sales forecasts, varied internal and external scenarios and their impact on your business and so on.
Contingencies: Take into consideration possibilities where the desired plan may not work and sales drop. Work on a plan to maintain cash reserves or other assets that can pull your business out of such situations.
Comparison: Compare the results of your cash financial statement with income projections and sales to check if they are aligned with your business goals. You can accordingly review and modify the plan to achieve the targets as planned.
| What to include in a business finance plan? |
| Sales projections: Expected growth, sale targets, product pricing and profit margins |
| Budgeting: Fixed expenses, variables, working capital, rents, registration & licences, marketing |
| P&L: Monthly sales and expenses, income projections over a period |
| Assets & liabilities:: Infrastructure, equipment and machinery, stocks, taxes, loans |
| Teams and structure: New hiring, team sizes, resource allocation |
| Break-even predictions: Estimating realistic sales, test scenarios |
Conclusion
Business finance includes a complex, multi-layered process and requires incorporating of a number of factors to successfully contribute to the growth of a business.
Companies need to give particular emphasis on business finance and take timely and appropriate measures to avert situations where improper management can lead to adverse effects on the functioning of the company.
The above-mentioned insights help in creating a workable plan for small and upcoming businesses to meet the objectives of business finance.
