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a Business Plan
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Although "poor management" is cited most frequently as the
reason that businesses fail, inadequate or ill-timed financing is a close
second. Whether you're starting a business or expanding one, sufficient
ready capital is essential. But it is not enough to simply have sufficient
financing; knowledge and planning are required to manage it well. These
qualities ensure that entrepreneurs avoid common mistakes like securing
the wrong type of financing, miscalculating the amount required, or underestimating
the cost of borrowing money. Before launching your venture, think through
the following financial issues to develop your business acumen and lead
to solid planning. Then, have your accountant review your plans
and advise you of its fiscal viability. In order to determine how much seed money you will need, you must estimate the costs of your your business for at least the first several months. Every business is different, and has its own specific cash needs at different stages of development, so there is no universal method for estimating your startup costs. Some businesses can be started on a shoestring budget, while others may require considerable investment in inventory or equipment. It is vitally important to know that you will have enough money to launch your business venture. To determine your startup costs, you must identify all the expenses that your business will incur during its startup phase. Some of these expenses will be one-time costs such as the fee for incorporating your business or price of a sign for your building. Some will be ongoing, such as the cost of utilities, inventory, insurance, etc. While identifying these costs, decide whether they are essential or optional.
A realistic startup budget should only include those things that are necessary
to start that business. These essential expenses can then be divided into
two separate categories: fixed and variable. Fixed expenses include rent,
utilities, administrative costs, and insurance costs. Variable expenses
include inventory, shipping and packaging costs, sales commissions, and
other costs associated with the direct sale of a product or service.
Projecting Operating Income and Expenses Next, estimate the "working" capital you will need to keep operating for six to twelve months. Operating expenses include:
In addition to business operating capital, you will also need reserve capital
to cover your personal expenses. This estimate will include all
your normal living expenses, such as food, household expenses, car payments,
rent or mortgages, clothing, medical expenses, entertainment, and taxes
for you and your family. Finding Capital After you have estimated your startup costs, working and operating capital for six to twelve months, and your personal expenses and obligations, you may discover that you need more startup capital than you thought. Your accountant, attorney, and trusted business associates and family can help you decide the best way to secure additional capital. Here are the most common options: 1. Personal savings: The primary source of capital for most new businesses comes from savings and other personal resources. While credit cards are often used to finance business needs, there are usually better options available, even for very small loans. 2. Friends and relatives: Many entrepreneurs look to private sources such as friends and family when starting out in a business venture. Often, money is loaned interest-free or at a low interest rate, which can be beneficial when getting started. 3. Banks and credit unions: The most common sources of funding, banks and credit unions, will provide a loan if you can show that your business proposal is sound. This requires submitting to a loan officer a comprehensive statement of your personal financial condition and a business plan with your financial projections. If you need help in preparing your loan application, take a course for small business owners at a local community college or visit your nearest SBA office to get assistance from a SCORE counselor. 4. Angel Investors and Venture capital firms: These individuals and firms help expanding companies grow in exchange for equity or partial ownership. 5. Additional Sources of Capital: Credit Cards Note: Before borrowing money for your business, be sure to speak with your attorney and accountant about the personal, legal and financial ramifications of each option. From our experience, even the most benign choices can carry unexpected drawbacks. Loans from friends and family members may seem like a terrific option, UNTIL a missed payment starts to erode your personal relationship. Be particularly aware of the risks associated with second mortgages and home equity loans. Although you are technically "borrowing from yourself" by freeing up the equity in your house, a default could leave you homeless.
Borrowing Money To successfullly obtain a loan, you must be prepared and organized. You must know exactly how much money you need, why you need it, and how you will pay it back. You must be able to convince your lender that you are a good credit risk. Terms of loans vary from lender to lender, but there are two basic types: short-term and long-term. Generally, a short-term loan has a maturity of up to one year. These include working capital loans, accounts receivable loans and lines of credit. Long-term loans have maturities greater than one year but usually less than seven years. Real estate and equipment loans may have maturities of up to 25 years. Long-term loans are used for major business expenses such as purchasing real estate and facilities, construction, durable equipment, furniture and fixtures, vehicles, etc. How to Write a Loan Proposal Approval of your loan request depends on how well you present yourself, your business, and your financial needs to a lender. Remember, lenders want to make loans, but they must make loans they know will be repaid. The best way to improve your chances of obtaining a loan is to prepare a written proposal.
1. Have you invested savings or personal equity in your business totaling at least 25 percent to 50 percent of the loan you are requesting? No lender or investor will finance 100 percent of your business. 2. Do you have a sound record of credit-worthiness as indicated by your credit report, work history and letters of recommendation? This is crucial. 3. Do you have sufficient experience and training to operate a successful business? 4. Have you prepared a business plan that demonstrates your understanding of and commitment to the success of the business? 5. Does the business have sufficient cash flow to make the monthly payments? Applying for a Loan When applying for a loan, you must prepare a written loan proposal and application that include all of the information in your business plan, along with additional details about your fiscal stability. You must clearly and briefly explain who you are, your business background, the nature of your business, the amount and purpose of your loan request, your requested terms of repayment, how the funds will benefit your business, and how you will repay the loan. Your bank is in business to make money. Consequently, when a bank lends money it wants to ensure that it will be paid back. The bank must consider the 5 "C's" of Credit each time it makes a loan: Capacity to repay is the most critical of the five factors. The prospective lender will want to know exactly how you intend to repay the loan. The lender will consider the cash flow from the business, the timing of the repayment, and the probability of successful repayment of the loan. Payment history on existing credit relationships - personal and commercial - is considered an indicator of future payment performance. Prospective lenders also will want to know about your contingent sources of repayment. Capital is the money you personally have invested in the business and is an indication of how much you will lose should the business fail. Prospective lenders and investors will expect you to contribute your own assets and to undertake personal financial risk to establish the business before asking them to commit any funding. If you have a significant personal investment in the business you are more likely to do everything in your power to make the business successful. Collateral or guarantees are additional forms of security you can provide the lender. If the business cannot repay its loan, the bank wants to know there is a second source of repayment. Assets such as equipment, buildings, accounts receivable, and in some cases, inventory, are considered possible sources of repayment if they are sold by the bank for cash. Both business and personal assets can be sources of collateral for a loan. A guarantee, on the other hand, is just that - someone else signs a guarantee document promising to repay the loan if you can't. Some lenders may require such a guarantee in addition to collateral as security for a loan. Conditions focus on the intended purpose of the loan. Will the money be used for working capital, additional equipment, or inventory? The lender will also consider the local economic climate and conditions both within your industry and in other industries that could affect your business. Character is the personal impression you make on the potential
lender or investor. The lender decide subjectively whether or not you
are sufficiently trustworthy to repay the loan or generate a return on
funds invested in your company. Your educational background and experience
in business and in your industry will be reviewed. The quality of your
references and the background and experience of your employees will also
be considered.
Understand Your Cash Flow Statement Your business must have a healthy cash flow to survive. Cash flow is the amount of money available in your business at any given time. To keep tabs on cash flow, forecast the funds you expect to disburse and receive over a given period of time. Then you can predict deficiencies or surplus in cash and decide how to respond. As your actual data become available, compare it to the monthly cash flow estimates you previously made to see how accurately you are estimating. As you do this, you will learn how to make more accurate estimates and plans for the coming months. As your ability to estimate improves, your financial control of the business will increase. The creative business owner works with his or her accountant to use the information gleaned from all of these financial tools to make a variety of managerial decisions: buying supplies, expansion, hiring employees, identifying tax breaks, and other milestones that will shape the future of the business. Money truly is the lifeblood or bottom-line for your home-based venture.
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