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Financing is one of the main concerns for small business owners. It is also one of the main reasons many small businesses fail, particularly poor financial management. As many small business owners and entrepreneurs launch or expand their operations, they will have to decide on how they can finance their plans. Making the decision between debt or equity is one of the key financing decisions most small businesses will have to make at some point in their tenure. While each category of financing has its own merits and drawbacks, the reality is that very few businesses are solely funded by just one. Many small business owners start out by investing their own savings into their businesses. In fact, more than half of small business utilize their personal funds in their business, while a similar percentage have opted for debt as a form of financing. For those that use both, maintaining an equilibrium between the two can be a delicate balancing act; one that must be attempted carefully, and that is completely unique to your business.
Get To Know Your Competitors
Before you can strike the right balance in your financing sources, you must first be aware of what the correct balance is. The best way to get an accurate estimate is to research your competitions, including companies of similar size and capital infusions. This gives you a great starting point when it comes to seeking appropriate financing and an idea of what balance is working well (and what is not). Insightful information can be gained from competitors, published accounts or past financial trend analysis.
Formulate Your Personalized Requirements
Your capital structure will be unique to your business, and while there will be a few similarities to other competitors in the industry, your balance does not necessarily have to mirror theirs completely. Your personal requirements will depend on your attitude to risk, the nature of your business operations, and even your future business plans and forecasts. Some owners prefer not to give up equity stakes in their company, and as a result, accept the cost of debt as an acceptable payment for keeping control. On the other hand, the refusal of debt could be the factor that is limiting the growth of the business.
Pay Attention To Your Ongoing Cost Of Capital
Each form of financing comes with a cost. Debt such as loans and credit cards come with interest charges, and in some cases, can be quite high. In 2019, the average APR rose to 17.69 percent for credit cards, while business credit cards can carry interest rates topping 29 percent in some cases. The lower your cost of capital is on debt outstanding, the better it is for your profit margins. Higher rates also impact your overall weighted average cost of capital in your business. Ideally, you want higher debt levels when the interest rates are low and vice versa.
On the other hand, a higher debt to equity ratio can come with its own set of perks. In the past, much has been said and debated about the fact that is can actually be cheaper to finance a business using debt than equity. Once you can trace the use of the borrowed funds to use in the business, any loan interest paid is classed as deductible. When it comes to financial services and tools, your credit rating will also impact on the options and the cost you incur. Second chance checking accounts cater for those that have a less than stellar credit history, and lenders such as these also place less weight on credit scores, which could equate to lower interest cost of debt charged.
Build Your Value Without Tapping Into Debt
Most small business owners tap into additional financing (including debt financing) in an effort to expand, and in turn, increase the value of their business. Building your business and brand value adds to your equity, and tips the scales in your favor when it comes to your debt equity balance. There are many ways you can do this, preferably without the use of debt. This is because debt will come with a cost attached to it, which in turn depletes the returns achieved. Growing your business without using any debt can be done by perfecting your business cash flow and using it as your main (or only) source of income. This is a vital skill to have, since 82 percent of small businesses fail thanks to poor cash flow management or understanding. Another way you can build your value is to build up your retained earnings using business profits, or alternatively, focus on building your brand both offline and online.
Keep in mind your debt to equity ratio will adjust and fluctuate throughout the lifetime of your business, as it goes through the different stages from inception to maturity, and as industry conditions change. Therefore you should be sure to leave room for both expansion and retraction in both categories. Getting your small business’ financing mix right is never a straightforward job; it requires constant adjustment and monitoring. It is, however, a vital part of the business success and sustainability puzzle. After all, it takes money to make money.