Starting and running a business is hard work and involves long hours and multitasking. Business owners need to be skilled at various areas such as sales & marketing, human resources management, accounting, dealing with a variety of suppliers and customers. One key aspect that is often overlooked is the importance of having the correct financing within the business.
Below are some key mistakes business owners make with regards to financing their business:
1) Underestimating start-up costs
In the start-up phase many new business owners are excited about the new business venture and the prospects they believe they can achieve and how quickly this can be done. But truth is despite the well thought out plans, business owners quickly realise that the costs they estimated to start and carry the business over the first few months is usually well below actual costs. Costs can turn out to be 2 or 3 times higher than forecast and this will have a major impact on the cash flow of the business and the risk of survival is significantly reduced.
It is important to be conservative in the initial costing process and budget for higher costs and ensure financing is in place to cater for the higher level of costs and capitalise the business accordingly.
2) Profit is not Cash Flow!
Most businesses fail because of the lack of cash flow. Positive cash flow is the life blood of any business and is critical for the business survival. Many business owners believe profit is the most important in the business accounts, but this is not correct, positive cash flow is the most important. A business owner needs to regularly review both their profit and cash flow. A business can have a successful and very profitable product range but if customers are large companies and pay accounts 60, 90 or even 120 days after invoice, this has significant impact on cash flow, especially if your terms with suppliers is 30 days. So it is key to fully understand the working capital cycle (accounts receivable, accounts payable and inventory) and the impact of changes within each on the business.
3) Funding Capital Expenditure out of Cash Flow
Business owners should in all cases, where possible, match the correct financing with the products & equipment they purchase. Stock / Inventory purchases are usually short term in nature and as such should be financed with working capital / short term bank finance (Overdrafts, Inventory Finance, Debtor financing). Even if the business has had a great quarter and generated excess cash, this should be used for short term commitments and not for buying long term assets. Machinery, motor vehicles and other capital expenditure items which have longer term lifespans should be financed over longer periods (eg. Asset Finance up to 5 years).
4) Not having your financial statements up to date
Keeping proper and up to date financial information is critical not only for management of the business but being prepared when applying to lenders for financing. There are a host of cost efficient accounting packages available and these should be discussed with your account and a suitable package chosen to keep business records up to date.
Business owners also need to forecast into the foreseeable future and it is important that these income and cash flow forecasts are reviewed regularly to monitor the performance against expectations.
It is very important to produce realistic forecasts as there is nothing a lender likes less is 6 months into the loan, you approach them with an update saying you are way off the forecasts provided and are now breaching some of the covenants imposed by the lender.
5) Using your current bank for all financing
Banking with one lender for all your needs does have advantages. But there are also disadvantages in that the products, services and pricing may not be the most competitive. This is where a good broker can play a significant role in understanding your needs and finding a suitable solution for you from the large pool of lenders they deal with.
6) Be clear open and honest with your broker and ultimately the lenders
Following the point in 4 above it is important that business owners be open, honest and transparent with their broker and lenders. When applying for financing lenders will need clear answers to the following key questions:
i) What is the finance for?
ii) What type of finance is required? (Short term, Long Term)
iii) How will it be repaid (from what sources: Cash flow, New Debt / Equity, Proceeds from sale of assets etc)
iv) What security is available?
v) Clearly articulating the business plan and vision
vi) What equity / capital do the owners have at risk in the business (skin in the game)
7) Not fully understanding the terms and conditions of the finance
This is extremely important and a business owner should fully understand what is in the loan documentation and what terms and conditions are set and ensure that the business can abide by these terms and conditions. Things to be mindful of here are: restrictions to further borrowings, breakage costs, guarantors (limited / unlimited), security being taken and covenants on term loans. These covenants must be in line with the realistic business forecasts and be achievable. Any breaches in these covenants could lead to the lender calling a default and this will have a major impact on the business.
8) Mixing Personal and Business Finances
Right from the outset it is important to keep personal and business finances well separated. This not only provides for more accurate track record business income, expenses and financing requirements which makes tax filing and applying for finance a lot cleaner. Another important reason to keep personal and business separate is if you use your personal mortgage or line of credit to fund the business and there comes a time you want to increase you mortgage or take out new mortgage this may impact on your serviceability calculations by the lender, which could result in the finance application being declined.