sources of finance

Sources of Finance for Small Businesses

  • Definition: Finance is the money used to start or operate a business.

Types of Sources of Finance

  1. Loans from Family or Friends

    • Considered a personal financing option.

    • Terms (interest rate, repayment period) are negotiable.

  2. Credit Cards

    • Short-term financing option; repayable within a few months.

    • High interest rates (up to 17% p.a. or higher).

    • Expensive if not paid within interest-free days (typically 30 days).

  3. Bank Overdraft

    • Allows withdrawal beyond the deposited amount, with a set limit (e.g. $10,000).

    • Interest charged monthly on the overdrawn amount.

    • Suitable for short-term use only (few months).

  4. Term Loans

    • Long-term loans from banks, repayable over 1 to 10 years.

    • Factors considered by banks:

      • Quality of the business plan.

      • Collateral available (security for the loan).

      • Business’s repayment capacity.

  5. Lease Finance - can be long or short

    • Renting equipment for fixed periods.

    • Two types:

      • Finance Lease: right to purchase equipment at the end.

      • Operating Lease: must return equipment at lease end.

  6. Factoring

    • Selling owed amounts from accounts receivable for a fee thats less that amount they owe you to not have to deal with having to follow up on the clientsto ensure timely payments. This can improve cash flow and reduce the burden of managing receivables.

    • Example: Selling $100,000 in receivables for $80,000 to gain immediate money.

Key Considerations for Loan Applications

  • Business Plan: Essential for demonstrating viability and includes:

    • Operation details, market identification, growth strategy.

    • Projected cash flows for 2-3 years.

  • Collateral: Security (like land) to cover loan in the event of failure.

  • Capacity: Ability to make loan repayments based on cash flow projections.

Common Mistakes in Loan Applications

  • Lack of a detailed business plan.

  • Inadequate financial projections.

  • Poor understanding of revenue and costs.

  • Failure to provide collateral or security.

  • Without knowledge of the relevant industry (e.g., no prior experience).

Risk Factors Considered by Banks

When evaluating loan applications, banks consider:

  1. Lack of planning.

  2. Poor presentation of the business model.

  3. Lack of market understanding and reasonable pricing.

  4. Absence of a realistic marketing plan.

  5. Inadequate financial plans addressing working capital needs.

  6. Insufficient financial management skills.

  7. No prior business operation experience.

  8. Overspending on setup costs.

Example Case: Henry Battler’s Loan Application

  • Requested: $310,000 for a new tour bus business.

  • Issues identified:

    • No formal business plan submitted.

    • Lack of security for the loan (only an old vehicle).

    • No prior business or industry experience.

    • Poor understanding of pricing and financials.

    • Inadequate cash flow forecast.

  • Conclusion: Loan would likely be denied due to insufficient preparation and risk factors.

Example Case: Lucinda’s Business Financing

  • Planned business for selling bicycles; estimated cost: $300,000.

  • Personal assets available:

    • Motor vehicle: $19,000

    • Cash: $21,000

    • Computer: $2,500

  • Factors to Consider:

    • Possibility of borrowing from the bank ($279,000 requested).

    • Other sources of finance may need to include: crowdfunding, venture capital, or small business loans.

    • Short-Term Financing Example:

      • A bank overdraft is identified as short-term finance.

Summary

Understanding various sources of finance is crucial for aspiring business owners. Preparation, including a solid business plan and financial management insights, can significantly impact loan approvals and overall financial health of a business.