When early payment discounts are offered by suppliers, the cost of trade credit needs careful consideration as the effective interest rate can be very high compared to other forms of finance.
The 5 C’s of credit is one technique used by financial institutions to assess the credit worthiness and risks associated with lending to a business seeking debt finance. An understanding of the five C’s of credit combined with financial projections, will allow a business to be better prepared when approaching lenders for debt funding.
There is a wide variety of funding available for a startup business, but one of the fundamental decisions which must be made by the entrepreneur is whether or not to seek outside equity and long term debt finance to fund growth or to rely on bootstrapping finance methods such as founders equity, short term debt, and revenue to grow the business.
The fundamentals of a businesses trading activity are that it buys from a supplier, holds inventory, and sells to the customer. The amount of finance a business needs to carry out this day to day trading activity is known as the working capital requirement, and varies from industry to industry depending on the amount of time the business takes to pay suppliers, the amount of inventory held, and the time it takes to collect cash from customers.
Invoice factoring is a process of raising short term funding particularly suited to high growth start up businesses. The method involves the business selling its outstanding customer invoices (accounts receivable) to a factoring company for a cash advance to fund working capital.
The invoice factoring company is responsible for collecting the accounts receivable, and pays the business the remaining balance less any fees due, when the customer has settled the account.
A business with a high level of financial leverage (sometimes referred to as being highly geared) is considered to be more risky as finance costs need to be paid before equity owners get their return. However, in return for this higher risk a high level of financial leverage will give greater returns to the owners provided cash and profit are managed correctly.
A business plan financial projection will identify the funding requirements needed by a business both in terms of maximum or peak amount required and the length of time the funding is needed for.
The length of time the funding is required for is an important consideration when considering small business financing options. The general principle is to try and match the funding term to the assets being funded.
Investors are often the most critical readers of a business plan financial projections since they have limited knowledge of the background to your business and generally invest in riskier situations.
Investor business plan financial projections need to reflect the type of audience they are aimed at and the type of finance being sort. Investors have different requirements from lenders, and will look for different information in the figures.