Equity Investment for Your Business

Equity can be built up through retained earnings or by the injection of cash from either the owner or investors. Most banks want to see that the total liabilities or debt of a business is not more than four times the amount of equity. So if you want a loan for your business, make sure that there is enough equity in the company to leverage that loan.

Owners will be required to put some of their own money up when applying for a loan. This is where debt-to-equity ratio plays apart. Lenders will also evaluate a business on the following. Net worth, the amount of equity in a business, lenders usually require a second source of repayment.
Collateral is personal and business assets that can be sold if the business is not able to repay the loan. If the business has not acquired capital it will need a co-signer to obtain a loan. Collateral is an insurance policy that the lender will be able to get the money loaned back.

Collateral-coverage ratio is computed as part of the loan evaluation process. This ratio is calculated by dividing the value of the discounted collateral by the loan request.

Lenders will also evaluate the borrowers’ ability to run a business.  The banks will take into account past management experience, as well as education.  It is the banks job to protect their customer’s money.  That is why lenders dig into every aspect of the business, and the owner before issuing a loan.

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Crowd-sourcing for Funding

Crowd-sourcing is a way to fund a business without using traditional sources? Crowd-sourcing is the act of soliciting funding through large groups of people, usually done through social media groups. It is similar to flash-mob marketing.

Crowd-sourcing is an old funding concept, which has received a new name. Crowd-sourcing is the action of asking people to prepay for products so a business can create the product. Sites have been built to facilitate crowd-sourcing. Kick starter is probably the best known site for crowd-sourcing. In its simplest sense crown-sourcing is, outsourcing over a large group. This allows small contributions in high volumes to push new ideas. It is easier to ask for $5.00, compared to $500,000. Internet and social media has made it easy to obtain $5.00 from 100,000 people.
Is crowd-sourcing to fund a business a viable option? Research shows the crowd-funding industry has raised $2.7billion in 2012, across more than 1 million individual campaigns globally. In 2013 the industry is projected to grow to $5.1 billion. The use of crowd-sourcing will grow in the future.
The original crowd-sourcing model involved the entrepreneur going to the company, and convincing them to pay for a product prior to production. If a new business owner can successfully pull this off they are securing both funding, and a customer. These are two of the largest hurdles a new business will need to get over. Asking for payment before production is not an easy thing to accomplish. It takes a lot of trust from the purchaser to give money without a product to sell. If a business is going to make this happen, they will need a strong business plan to present to the buyer. This is the best form of crowd sourcing if it can be done. The problem is convincing a large crowd to trust a business is hard.

Donation funding is the most common model for crowd-sourcing. Donations to entrepreneurs was how current crowd-sourcing gained popularity. Groups of people with similar interests will fund a business. Seth Godin calls these niche groups tribes. Generally these tribes will only fund companies that are part of their society. Artistic products are most likely to find success in donation funding. Traditional production, and service oriented companies can still generate cash using donation funding. if a business is going to find success in donation funding it will have to connect with an audience. There will need to be something that will move people to donate to the start-up. Tom’s is an example of a company that has been able to bridge the gap.
Investment crowd-funding has become more popular, and will continue to grow. Attracting a large group of investors by offering stake in the company is the definition of investment crowd-funding. Unlike the donation model, financial crowd-funding is entered into by investors in an attempt to profit. This allows large capital investors to reduce risk, and lowers the barrier into capital investment. This will allow the average population to become Venture Capitalist, while increasing the amount of funds available to start-ups.

It is necessary to reflect on the negatives of investment crowd funding. Investment crowd-funding is the act of giving up partial control of a business. The owner must be willing to give up full control when they decide to use investment crowd-funding. A positive to using crowd-funding instead of traditional investment funding, is the spread of small shares will ensure that one person will not have a large control, which will be leveraged against the owner.

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Bootstrap Financing for Your Business

Bootstrap financing comes from the idea of pulling oneself up from the bootstraps. Bootstrap financing is defined as a business that Self-funds its costs. The company will grow as it creates revenue. The goal is to have a business that is self-sustaining. The objective of bootstrap funding is to keep costs low, and avoid debt. Businesses looking to use bootstrap financing to fund: need to be creative to keep costs low.

What are the benefits of bootstrap funding? The biggest advantage of bootstrap funding is avoiding debt. Companies in debt have to please lenders, making lenders the boss. Having debt causes owners to lose their independence, and creative freedom. If an owners’ goal is to live by their own rules, bootstrapping is worth considering.

Bootstrapping removes the distraction of debt, allowing Entrepreneurs to focus on customers. The purpose of a business is to solve a problem. It is impossible to fix customer’s problems, if your company has a bigger problem.

Taking out a loan allows for quick growth in the beginning stages, but can limit growth over time. A business needs quick, sustained growth to use debt as an advantage. This is hard for a small business to achieve. A poor position for a small business is, having to cut production, or close the business.

If an entrepreneurs plan is to start a business, and sell it for a profit bootstrap financing is a good option. A debt free business is more appealing to buyers than a business with debt. When sold a debt free business is pure profit.

Remaining debt free allows total control when negotiating the sale. If the owners plan is to grow a business, and sell for profit: Bootstrap financing is your best option.
Business risks are lower when a company is self-financed. If things go bad, the owner only loses what they put into the business. Zero is better than being negative. Losing savings is bad, but not losing a house is worse. Knowing that will reduce stress, and keep focus in the right places.
Bootstrap financing may be the wrong option for a business. The bootstrap method is only effective in niche or low cost markets. The competition and the owner’s personal-finances will determine if bootstrap funding can work.

To finance a start-up using the bootstrap method, the owner’s personal finances will need to be in good standing. Personal finances can stop any funding source. They become a bigger issue in self-funded businesses. It is impossible to self-fund a business without funds. While planning, a business must have the ability to fund operating needs.

Some businesses are better suited for bootstrap financing than others. If a business needs large amounts of cash, bootstrapping is out of the picture. This will include all businesses that need high sales volume. Production markets are bad places to try bootstrap financing. Few people can fund the costs of starting a manufacturing plant using personal-finances.
If survival is an owners’ reason for starting your business, it will be hard to self-fund. Many businesses begin as a way to fill the owner’s employment needs. If your motivation to start a business is preservation, time is your enemy. Bootstrap companies trade initial profit, for a self-sustaining company in the future. The Entrepreneurs’ personal stability, will determine if waiting is an option.

Competition will be a factor in deciding if bootstrap financing is an option. If you are trying to enter a market that is competitive, bootstrap financing will limit your ability to compete. You need to understand your limitations, when working on a small budget. Niche markets will be your market. Even in a niche markets, you will have to use superior quality as your advantage.
Being a bootstrap company limits growth in the beginning. To use this method, you will need patience. Opportunities will present themselves, and you will be unable to act.
Bootstrap financing limits strategic options available to start-ups. Bootstrap financing is a great option, but is has limitations. This model works best in market with weak competition, and low production costs.

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Preparing Financial Statements

Understanding financial statements, decide the success of small businesses. They direct, and help businesses avoid breakdowns in the business. Financial statements assist in preparing taxes, and applying for loans. That is not the end of their value. Financial statements build a company’s balance sheet.

The balance sheet is a snapshot of a business’s finances. Balance sheets need three things; assets, liabilities and net worth. The elements of a balance sheet change with daily operations, and log the business’s activities. Tracking the changes of a balance sheet over time will show the real financial state of a business. Understanding how well processes are running will strengthen the operations of the company.

Liabilities and net worth on a balance sheet are sources of funds. Liabilities and net worth are creditors, and investors who provided cash to a business. They enable a business to expand operations. These funds create assets. Assets represent the use of funds. A business uses cash, or other funds provided to buy assets. They include business owned property that has value.
Liabilities represent obligations to creditors while, net worth represents the owner’s investment in the business. Creditors and owners are “investors” in the business with the difference being the time-frame in which repayment is expected. Current Assets are anything of value that is owned, or due to the business. These are included under the Asset section of a Balance Sheet. Current assets mature in less than one year.

Cash is what pays bills, and obligations. Inventory, receivables, land, building, machinery and equipment do not pay obligations. Selling equipment has cash value, but is not considered an asset. Mismanaged cash forces a business into bankruptcy. Cash includes all forms of short-term cash sources.

Accounts receivable are payments due from customers. Inventory sold, and shipped needs an invoice. Invoices are agreement for payment at a later date. The receivable exists for the period between the selling of inventory, and the collection of cash. Receivables are equal to sales on a spreadsheet. As sales rise, the investment you must make in receivables also increases.
Materials purchased to create profit, is inventory. The business purchases raw material, to sell as finished goods inventory. A business that sells a product, inventory is the first use of cash. Selling inventory does not create cash, it creates a receivable. Collected at the agreed time, a receivable becomes cash. Goods sold are not immediate cash. Inventory management is important. Unsold inventory ties up cash. Keeping inventory low allows a company to grow, by freeing up cash. Inventory shortages will result in lost sales.

Notes receivable are claims due to the business from a loan made, like promissory notes. Notes receivable are claims due from one of three sources customers, employees or officers of the business. Customer receivables are when a customer fails to pay an invoice according to the agreed-upon payment terms. Customer obligations may be converted to promissory notes. If an officer takes money from the business, it is declared as a dividend, or withdrawal. It is reflected as a reduction in net worth on the balance sheet. Treating it differently will manipulate the businesses stated net worth.

Intangible assets are prepaid expenses, at a later date. Example of this is insurance. It is prepaid, and expensed each month. If using standard accounting procedures intangibles get expended as purchased. An exception is, purchased patents. They are amortized over the life of the patent. Intangibles are assets with an unknown life span. They may never mature into cash. For analysis purposes, intangibles get ignored as assets, and deducted from net worth. Their value is unknown. Examples are patents, or Research and development.
Other assets consist of miscellaneous accounts, deposits and long-term notes receivable. They are converted into cash when the asset is sold, or note is paid. Total Assets represent the value of all the assets owned by a business.

Current liabilities are obligations that require payment within 12 months. A business’ current liabilities are the bills that can cause it to go bankrupt. Constant monitoring of all current liabilities is vital to the businesses’ success. A company needs to be able to forecast production needs to ensure funds will be available to pay current liabilities. Keeping current on liabilities will keep creditors happy. This allows a business to keep a healthy line of credit established. Having access to short term credit will allow a business to have cash on hand to pay for materials, and inventory.
Non-current liabilities are obligations payable the following year. The non-current part of long-term debt is the part of a loan not due in the next 12 months. Contingent liabilities are potential liabilities, without due dates. They are avoidable liabilities, like lawsuits. Long term debt provides cash for long-term asset buying.

Notes payable are promissory notes with short-term due dates of less than 12 months. Most are payable on demand. If not they have specific maturity dates less than one year. Notes payable include only the principal amount. Any interest owed gets listed under accruals. Proceeds from notes payable, finance inventory and receivables. The use of funds must be short-term so the asset can create cash before the obligation is due. Businesses should only borrow money to cover seasonal swings. The money will cover increased costs in inventory needed to cover demand.
Accounts payable are obligations to suppliers, who have provided a service to the business. Accounts payable are like accounts receivable. Taking advantage of payment terms will keep costs down. Allowing the business to sell the goods produced, before payment is due on materials.
Accrued expenses are obligations owed, but not billed. These include wages, and payroll taxes. These expenses will get paid over a period of time like interest on a loan. Labor-related categories will vary with payroll policies. For example, if wages get paid weekly, the accrual is one week’s payroll, and payroll taxes.

Contingent liabilities are potential liabilities that are not listed on the balance sheet. They get placed in the footnotes, because they may never become due. Contingent liabilities include lawsuits, and warranties. A lawsuit may not end in litigation. Liabilities belong in the footnotes to represent a potential liability. It will remain there until it either becomes a liability, or is no longer a threat to the business.

Total liabilities represent the sum of all monetary obligations of a business and claims creditors have on its assets. Equity is represented by total assets, minus total liabilities. Equity or net worth is the most patient, and last to mature source of funds. It represents the owners’ share in the financing of all the assets.

The income statement, also known as the profit, and loss statement, includes all income and expense accounts over a period of time. This financial statement shows how much money the business will make after expenses are accounted for. An income statement does not reveal hidden problems, like insufficient cash flow. Income statements are read from top to bottom, and represent earnings and expenses over a period of time.

Businesses need a cash flow analysis to start, operate, and expand operations. Even with a cash flow analysis, many small business owners often have trouble managing, and maintaining cash. Inaccurate cash flow analysis or lack of available cash can affect the everyday operations of your business, and eligibility to receive a loan.

Cash flow is the movement of money in and out of a business. The processes of cash flow are explained in the following sentences. Inflow which comes from operations is the sale of goods, services, loans, lines of credit and asset sales. Outflow occurs during operations, as business expenditures, loan payments and business purchases. It is necessary to balance these, and maintain a reasonable balance of cash on hand at all times.

A cash flow system will manage funds to pay costs of operations, and help the business forecast potential problems in the future. Profit, loss statements, and income statements are used to determine projections of future cash flow trends. A cash flow statement will also accounts for non-cash items, and expenses to project proper financial statements. Cash flow analysis statements display changes, and available net cash. Cash flow analysis statements are separated into three parts.

Two types of cash flow are inflow, and outflow. Inflow is any cash that is coming into the business.  Outflow is the flow of cash leaving the business.  Inflows and outflows is what are used to balance accounts.  All businesses boil down to inputs, and outputs.  The point is to have more inputs than outputs.

The operating activities section evaluates net income, and loses of a business. Assessing sales, business expenditures and income from non-cash items the business can adjust the in, and outflows of cash transactions to determine a net figure.
The investment activities section reports purchases, and sales of long-term investments. Examples are property, assets, equipment and securities. When a company purchases equipment for the business it is considered an inflow.

Financing activities, this section covers cash flow trends of money related to financing a business. A loan has both inflow, and outflow of cash.  The loan would be considered an inflow.  While the payments made on the loan would be considered an outflow. Both the inflow and outflow will be recorded in this section.

Break-even Analysis is the point that the business will be able to cover expenses.  At this this point the business will begin to make a profit.  Lenders will expect borrowers to be able to forecast a break-even point.

To calculate break-even point, a business will need to identify both fixed and variable costs. Fixed costs are expenses that do not vary, known as overhead costs. Fixed costs are not affected by sales volume. These are expenses regardless of sales volume. Variable costs vary with sales volume. Cost of purchasing inventory, shipping and manufacturing a product effect your variable cost. To calculate break-even point uses this equation: Fixed costs/ (unit selling price – variable costs).

Debt-to-equity ratio is the amount of debt the company has, divided by the company’s assets. This is the amount of money borrowed related to the amount of money invested in the business. Having larger amounts of capital invested in the business, the easier it will be for a company to obtain funding.  Reinvesting into the business shows the seriousness of the owner, and eases the minds of investors, because they know they can recoup any losses by selling assets.
Businesses with high equity ratios should seek debt financing. If a business has high debt, the first step is to increase equity to receive a loan. With that in mind if a company is struggling to survive it may look at selling the business.  A business should only seek a loan if it is vital to expanding operations, not to stay alive.

Lenders will want to know the following before giving a loan. The ability to repay the funds received from a lender must be outlined in the loan package. Banks want to see both cash flow of the business and sources of collateral. Banks prefer to make loans with businesses that have been operating for a few years.  This is why starting out as a bootstrap maybe needed. If a business can show regular profits for several years, lenders are more likely to loan.  Start-ups will need to make sure that the business plan is exact, and outlines financial projections accurately.
Lenders use credit reports to determine the ability of a client to repay. Terms will be determined by the information inside the credit report. Understanding what is on a credit report is vital. Errors often appear on credit reports, and are correctable. Credit reports are available through the three credit bureaus.

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