Securing the required funds is very important for the survival of your business especially in the start up phase. At the end of the day, it’s all about the returns you expected from such financing and the return on funding you actually received. To have positive results with such a comparison, optimum focus on the collection and flow of funds is a must from day one.
However, it’s not easy to precisely calculate the actual amount of funds that would be needed throughout the operation, nor is it easy to find the most economic source of such funds. Above that, cash, being something that can be highly manipulated, holds a huge risk of fraud. In a nutshell, proper financing for a small business is very influential in determining the success of the business, and on the other hand, it also holds a great risk of manipulation. To keep finance and its flow on a proper track throughout your business operation, you might want to look at it from two different perspectives: initial financing and financing for regular operation.
It depends on whether you want to invest your own money in the business, request the entire amount from outsiders, or even some portion of both. However, it’s believed to be beneficial from a businessman’s perspective that you call for the required money for the business from outsiders and invest whatever funds you have of your own into the most profitable investment opportunities. Doing so, you will experience the following benefits:
- You will have an actual idea about the cost of funds you are bearing, so you can keep a margin above the cost and thus set a reasonable target performance for your business. This helps to keep things on track.
- You will only have to bear the least possible opportunity cost on your own money.
Once you are clear about the source of financing, the next big step is to have a reliable estimate of the amount of financing you need. This phase requires you to have a proper idea about the size of your business, volume of your transactions, permanent working capital required and the amount of risk you are willing to bear. These items will help you make an estimate of:
- Growth size of the business: People generally desire a big size for their business (assuming they are risk averse businessmen). With this comes the need for a big size of the fund, and willingness to spend promptly in an area of need where growth opportunities are seen.
- Volume of transactions: Slightly different to growth size of the business, this gives an idea of the amount required in relation to the number of transactions you are willing to handle or the number of clients you are willing to serve. High amounts of transactions will initially need high funding.
- Permanent working capital required: It is an accounting concept that points to the amount of working capital you will need to maintain your business continuity, so that you are able to continue your operations even in a worst case scenario. This highly depends on the amount of risk you wish to bear at the cost of running out of working capital.
- Tolerance to risk: In simple financial terms, if you wish to maintain a less amount of funds to pay off liabilities and, instead, apply the available funds for revenue generation purposes, you are a risk taker. However, if you are the opposite, you will be conservative and keep the payment of liabilities in a higher priority, which will in turn demand more financing, inclusive of funds for payment along with funds for revenue generation.
An analysis of the above mentioned factors will give you an idea about the funds you need for the commencement of your business. Meanwhile, it is suggested that you follow the prudence concept, i.e. maximize your expected expenses and minimize your expected revenue, while planning for required funds.
Unlike initial financing, this phase will require you to keep the funds in track, rather than focus on the procurement of funds. The procurement of funds in this phase is required for the temporary working capital, the idea of which is easy to gather once the business starts. The major challenge here is to keep a proper record of the funds, which can be done by:
- Maintaining a cash flow statement: This is a statement where you record all the inflows and outflows of cash, and finally tally the cash balance as per the statement with what is available in the cash box. This is highly effective in ensuring that the cashier does not misuse the cash of the business. To make this more effective, you can separate the cash flows from operating activities from the total cash flows. This is done because the major concern with day-to-day operations is a positive cash flow from business operations, which is what a business is all about. The cash flows from other secondary activities can be separately studied and not mixed to determine the additional capital required to finance the operating activities. Examples of this include, but are not limited to, investing activities.
- Division of custody and records: To have an idea of the funds being used and that which needs to be drawn back or added, we will need to know the actual flow of fund. For this the custody of cash and records of cash shouldn’t be given to the same person. For example, if the same person is in charge of the cash box, and also the one to record the inflows and outflows, he or she can easily manipulate one and compensate the difference with another. This leads to a false impression of the finance and cash flow situation.
Thus, by having a clear estimate of the amount required to initiate the business (initial financing) and keep such financing on track (operational financing), one can solve the biggest challenges that arise when financing a small business.