Pen and documents on cash flow funding sitting on laptop keyboard
Maximising cash flow

How to choose the right type of funding for your business

One of the leading causes for SME failures is the lack of working capital and under-capitalisation. This can be for various reasons, including business growth and lack of sufficient profitability to fund growth.

Most business owners recognise the need for additional capital, but few know what form it should take: debt or equity, or perhaps a combination of both? 

When debt is the solution, should it be short-term, overdraft, term loan or factoring? 

An analysis of your business requirements by a well-qualified accountant will determine which funding combination meets the needs of your business' unique needs.

It's essential to put these solutions in place at the right time if your business is to survive and flourish. Delay could ultimately lead to you having to call in an administrator or liquidator and the loss of any asset that facilities are secured against, such as the family home. 

Planning for business funding

Prepare a budget by monthly increments for at least two years. Start with your profit and loss forecast including any capital expenditure requirements. 

Convert this into a cash flow forecast that integrates to profit and loss. This is called a ‘3D budget’. 

If your accountant doesn’t prepare budgets in this way, it is strongly recommended you seek other advice.

Discuss this with your bank or funder of choice and your accountant. The budget model will determine what level of growth and funding solution is best.

Happy team surrounding office desk acquiring cash flow financing

Common sources of debt and equity finance

Financial institutions such as banks, building societies, and sometimes credit unions offer a range of finance products with short and long-term finance solutions including business loans, lines of credit, overdraft facilities, invoice financing, equipment leases and asset financing. 

If you’re not too risk averse this can be cheaper than equity funding, but remember your personal assets, including your house, will probably be on the line.

If you have no real estate security, you may still be able to obtain equipment finance and debtor and trade finance arrangements, but you should plan carefully with the right adviser. If you want to grow quickly this is sometimes the best alternative.

Most suppliers offer trade credit terms that allow delayed payment for goods. Terms often vary and trade credit may only be offered to businesses that have an established relationship with the supplier. 

Sometimes overseas suppliers offer longer terms, which can be extended with a bank bill discount facility. Your 3D forecast will determine how it all fits together. 

Consider foreign exchange risk – this may have a major effect on your margins and profitability. Unsecured foreign exchange facilities are available from financial institutions.

Be very careful here. Many families suffer great pain from family funding models that go wrong. If you use your friend or parents’ house for security ask them to seek independent advice, and give them some equity as well as the third party interest to make the arrangements commercial. 

Always have your lawyer prepare a binding shareholder agreement with appropriate exit strategies. Begin with the end in mind.

This can be the most expensive of all funding if you don’t get it right. Look for the value-add beyond the money. Money is important but it is more important to get the right partners. 

There is a vast array of online options as well as venture capitalists for the larger deals. The reality is, in Australia, these options are rarely successful.

Self-funding is often the best first step in seeking finance. It involves funding purely through personal finances and profit from the business.

In most cases, investors and lenders will expect some level of self-funding before they agree to offer you facilities.

The bottom line

Find the right accountant, adviser and lawyer to assist you – their fees will be paid for many times over from the positive outcomes they give you.

Sound financial management is integral to long-term success. 

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