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Start Up Financial Plan:
Focus On Funding
At some point, no matter how carefully you monitor your cash
flow, you will have to borrow money from a bank. There are
two main reasons to borrow: to cover a temporary cash flow
gap and to provide working capital for the growth of your
business.
Plan ahead. A written financial plan-whether for a bank
or internal use-is a major step in the right direction. A
financing plan helps you avoid the causes of cash flow problems,
anticipate financing needs (for growth or for survival), and
helps keep your total borrowing under control.
A financing plan spells out responses to such questions as:
What are the business's needs? Why can't they be met from
retained earnings? Are operating profits going to be available
to meet long-term debt? How much is needed, when, and under
what terms? Most important, the plan should provide an answer
to the banker's biggest question: How will this loan be repaid?
You must be able to show that you can afford to service the
loan. One of the classic ways small businesses trip themselves
up is to use this year's financing to pay off last year's
debt. This pyramiding is doubly defeating. It creates a larger
debt load than is wise, and it is very discouraging to be
always struggling with debt even while profitability is increasing.
Be wary of using financing to conceal operating losses.
How do you put together a financing plan?
Start by identifying your business's different needs for
funds. Most of these will be covered by operating profits.
Those that cannot be (or cannot without making the liquidity
vanish) should be carefully analyzed to see whether more debt
should be sought. It's important to remember that if debt
financing is needed to cover a cash flow gap ordinarily caused
by insufficient operating profits, the underlying cause of
the shortfall must be identified and dealt with before financing
will do any good. Borrowing to paper over an operating problem
always leads to a worsened situation, tempting though it may
be at the time.
Suppose, for example, that your sales have fallen off and
costs have risen, making it clear that soon you'll have a
severe liquidity or working capital problem. If the lag in
sales can be cured without borrowing, fine. (You can almost
always take costs down a few notches.) If you will still have
a cash flow problem, then make sure that the borrowing won't
make it worse. If the sales problem can't be resolved, sooner
or later you'll be back to the bank to borrow more, thus driving
costs even higher.
Make sure you know your needs before going to the bank-both
in dollar terms and in what benefits that cash inflow will
have. Any banker you'd want to work with will ask what you
need the money for and whether you could raise it from operations.
To admit that you haven't looked for operating economies and
profits as a way to generate money is a sure way to lose credibility.
Enter the bank well prepared.
Legitimate financing needs fall into five related categories.
At any one time your needs may overlap several of these categories.
A start-up, for example, may face radical expansion, perhaps
requiring an acquisition or the launch of a new division.
Start-ups. A new business needs a combination of investment
capital and long-term debt. One error that cripples a lot
of small businesses is the use of short-term debt to finance
long-term needs. The basic rule in financing is to match the
term of the loan to both the term of the need and to the source
of repayment. Using a 90-day note for permanent financing
needs is very risky. Not only is there the ever-present danger
that the loan will not be renewed, but there is the added
disadvantage of never being able to plan more than 90 days
ahead.
Working capital shortages. After initial capitalization,
working capital should be generated from operating profits
over a long period. If you suffer from chronic working capital
shortages due to under-capitalization but are making some
operating profits, then the answer may be a term loan if you
can demonstrate that the loan will more than repay itself
in additional operating profits. Sometimes a modest working
capital loan will put a business over the hump, affording
enough breathing room to make much higher operating profits.
But remember, a working capital loan, which is paid back monthly
over a period of up to three to seven years, for example,
adds to any existing financial strain. If your business won't
generate sufficient operating profits to cover the payments
comfortably, then added equity is needed, not another loan.
- Using Credit Wisely
- Managing cash and securing capital are the
two biggest challenges small-business owners face, particularly
in the startup phase. To keep personal expenses separate
from business expenses, use business credit cards as
money management tools. Here are three ways they will
help you:
- Business credit card: Use it to make and manage
purchases, as well as cover travel and entertainment
expenses. Like a reserve of credit, a business card
gives you the flexibility to pay bills in full or revolve
your balance.
- Business check card: An ideal replacement for
cash and checks with the convenience of a debit card,
check cards allow you to draw on funds from a business
checking account. They are excellent for startups, since
they allow your company to establish a business relationship
with your bank.
- Business credit line: Providing an unsecured
line of credit up to $50,000, the credit line gives
businesses a source of working capital for emergencies
or growth opportunities.
Equipment and other fixed assets. Equipment and other
fixed-asset loans are about the clearest examples of matching
a loan to the need and payment base. Since these loans are
ordinarily secured by the equipment, the anticipated useful
life of the equipment becomes a major factor in the credit
decision. A rough guideline is that you can finance equipment
with a projected useful life of 10 years for up to 70% of
its life and up to 90% of its value. Don't buy fixed assets
on 90-day notes. The timing is wrong. If You're trying to
make your business work on sweat equity, you may want to go
ahead and pay off a piece of equipment more rapidly than we'd
recommend. That's an option, but a hard one to live with.
While equipment loans rarely go beyond 7 years, commercial
real estate may be financed over 10 or more years, depending
on the situation. Since you are building equity in equipment
and real estate from profits over a number of years, you should
finance it the same way.
Inventory, seasonal progress. These loans are short-term
and usually are tied to a clearly defined source of repayment,
such as one inventory turn, fulfillment of a contract, or
sale of a specific asset. Short-term notes are repaid from
short-term sources, clearly identified before the credit is
granted. Medium- and long-term debts, on the other hand, are
repaid from more indirect sources. A banker looks to proven
management ability (usually evidenced by a profitable history
and clearly understood plans) for repayment. Since there is
no single fast source of repayment, the risk is greater and
the decision more difficult. This is a crucial distinction.
A poorly run company may be a good short-term credit risk,
but for long-term credit, a business must show ability to
consistently generate profits. Remember, term loans come due
every month, adding to the drain on resources and, in turn,
increasing the risk and need for more careful financial management.
Sustained growth. The final major need for financing
is growth, which can outstrip working capital. As sales go
up, for example, liquidity goes down. A combination of investment,
lines of credit tied to receivable and inventory, and long-term
working capital loans is the common answer. Notice what this
implies. If you plan to grow, you must plan to generate profits
consistently, at the same time keeping your business liquid
to meet current obligations. To make sure that you maintain
liquidity, you have to be certain of your financing strategy.
The answer? A solid financing plan.
Work with your banker. If you aren't comfortable preparing
a financing proposal complete with financial statements, or
if you feel that your banking relationships could be improved,
get your banker involved in your long-term planning efforts.
Like all business professionals, bankers like to use their
skills. Since most businesses suffer from a lack of financial
management skills, and since most bankers have these skills,
it is to your advantage to make the first move. Invite your
banker to help you. Level with him or her. If you can't keep
communications open, then you won't get help-and it's quite
possible that you won't get the financing you need. By being
open, you'll enhance your credibility; better yet, you'll
more likely find that you can turn the banker's skills into
a positive resource rather than a roadblock.
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