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. The length of time the funding is required is an important consideration when considering small business funding options. The general principle is to try and match the funding term to the assets being funded. The theory behind this is that the funding should have been repaid before the asset needs replacing.
For example, if the requirement is for additional working capital, as these are short term trading issues, short term funding should be used. If the requirement is for a new machine with a five year operational life span, then medium term funding should be used, and finally, if the funding is required to purchase a property, this is a long term asset, and long term funding is used.
Types of Small Business Funding Options
The definitions of short, medium, and long term will vary depending on the nature of the business and the industry in which it operates, but generally small business funding options fall into the following categories:
- Short term funding – up to one year
- Medium term funding – one to ten years
- Long term funding – more than ten years
Short Term Funding
Short-term finance is used to fund working capital and day to day trading activities and includes the following small business funding options:
- Bank overdrafts
- Accounts receivable financing, including factoring and discounting
- Trade credit from suppliers
- Credit cards
Medium Term Funding
Medium term finance is generally asset based, and is used for project finance, or to fund capital equipment and includes the following small business funding options:
- Term loans
- Finance and operating leases
- Project finance
- Hire purchase
- Government grants
Long Term Funding
Long term finance is used to fund long term assets throughout the lifetime of the business and includes the following small business funding options:
- Share capital
- Venture capital
- Angel investment
- Long term bank loans
- Retained earnings
- Unsecured loan stock
- Convertible unsecured loan stock
Remember the business plan financial projections will only identify the amount and timing of the cash flows, it is important to get the right type of funding in place to ensure that the duration of the financing matches the profile of the cash flows of the business.
The correct type of finance will not only ensure that funding is available when needed, but it will also ensure that facilities are not put in place for too long resulting in excessive fees and interest payments.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University.