Table of Contents
Write Your Business Plan

3 Key Things You Need to Know About Financing Your Business Looking to fund your business? Here's what you should ask yourself before asking for money.

By Eric Butow

Key Takeaways

  • The myth many entrepreneurs believe about sales growth
  • Dealing with the cash flow conundrum
  • What you should ask yourself about your business before asking for funding

Opinions expressed by Entrepreneur contributors are their own.

This is part 10 / 12 of Write Your Business Plan: Section 1: The Foundation of a Business Plan series.

It doesn't necessarily take a lot of money to make a lot of money, but it does take some. That's especially true if you envision very rapid growth as part of examining your goals and objectives. Energetic, optimistic entrepreneurs tend to believe that sales growth will take care of everything and that they can fund their growth by generating profits.

But this is rarely the case for one simple reason: You must pay your suppliers before your customers pay you. This cash flow conundrum is why many fast-growing companies must seek bank financing or sell equity to finance their growth. They are growing faster than they can afford.

"The only reason you go out of business is that you run out of money. You run out of cash. You owe people money. You go bankrupt. You fail," says Sabrina Parsons in her blog post "How We Made It Through a Recession, Became a Subscription-Oriented Business, and Stayed Cash Flow Positive.

Related: 8 Ways to Fund Your Start-Up

She continues, "Even though the reasons for failure can be related to marketing, implementation, supply change, fulfillment, or an overall economic slowdown, the proof is in the numbers. If you can manage those numbers and understand what lower sales are going to do to your cost structure, or if you understand areas where you can become leaner without affecting your core business, you'll be able to get through tough times. You're going to position yourself to grow in healthier ways because you will be very aware of all the levers that drive your business."

Sometimes, the cash flow gap is huge. For example, pharmaceutical companies may spend hundreds of millions of dollars in a multiyear project to develop and bring to market a new drug. These companies must have large cash flows from other products to fill the gap or seek loans or other forms of financing to avoid running out of money before having a market-ready product.

Related: 21 Ways To Quickly Fund Your Business Growth

Other companies require much smaller amounts of capital to finance their ongoing operations. Small service firms such as local web design companies or carpet cleaners frequently operate on a cash basis, getting paid with cash, check, or credit card at the time they perform their services after making only small outlays for supplies in advance. But as a general rule, your business will likely have to consider financing.

Now is the time to think about some issues that will surface. Start by asking yourself what kinds of financing you are likely to need—and what you'd be willing to accept. When you're short of cash or expect to be short of cash, you might think that almost any funding source is just fine. However, each kind of financing has different characteristics that you should consider when planning your future. These characteristics take three primary forms.

Related: Starting A Business, Issues You've Likely Overlooked

Three Things to Consider Before Financing

  1. The amount of control you'll have to surrender An equal-equity partner may, quite naturally, demand approximately equal control. Venture capitalists often demand significant input into management decisions by placing one or more people on your board of directors. Depending on personal style, Angel investors may be very involved or not involved. Bankers, at the other end of the scale, are likely to offer no advice whatsoever as long as you make payments of principal and interest on time and do not violate any other terms of your loan. Second, consider the amount of money you are likely to need. This means carefully considering your startup needs and your ongoing operational needs projected for several years.
  2. Funding sources Once you have determined whether you can launch and run a business for $20,000, $200,000, $2 million, or $200 million, you can consider the various funding sources. In fact, you may need to consider several funding sources. Almost any source of funds, from a bank to a venture capital firm, has some guidelines about the size of financing it prefers. Anticipating the size of your needs now will guide you in preparing your plan.
  3. Cost. This can be measured in terms of interest rates and shares of ownership, as well as in time, paperwork, and plain old hassle. At the top of the list are public offerings of stock, which may cost several hundred thousand dollars in legal and accounting fees to put together and require a great deal of your own time and attention.

Related: Why You Should Do Everything You Can To Self-Fund Your Business

What You Need to Know About Working Capital

Working capital is the amount of money a business has in cash, accounts receivable, inventory, and other current assets. (Current assets will likely be turned into cash within a year.) Net working capital, which is what this term usually refers to, is current assets minus current liabilities. (Current liabilities are things like accounts payable to suppliers and short-term loans due in less than a year.) The higher the net working capital you require, the greater your financing needs will likely be.

Low-Budget Businesses

You can start a very low-budget business and write a business plan as it evolves to bring in capital for advertising, marketing, and/or expansion. Many service businesses revolve primarily around using your time, motivation, knowledge, ingenuity, communication skills, and other factors that do not necessitate much outlay of funds. Consultants, counselors, coaches, cleaning services, web designers, writers, organizers, and many other possible businesses can be started by you in your home with very little funding.

The main cost will be promoting what you do, which can be done online and by word of mouth. Websites are inexpensive to build, and once you get started, you can put your initial income back into the business for a while. Then, when you have a list of clients and even some testimonials from them, you can begin working on your business plan to build up your business.

Related: Starting A Business: Get Focused

Where to Find Financing Ideas

Many enterprises can be started with the help of modest amounts of cash, no more than the contents of a small savings account. Here are some good places to find business ideas that can spark your own:

Related: 4 Signs That Your Small Business Needs Funding

You can also get many startup business ideas in Start Your Own Business: The Only Startup Book You'll Ever Need (Entrepreneur Press) by the Staff of Entrepreneur Media, Inc.

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