1 Financing your business
There are three main sources of business funding:
- Equity financing – contributed by the owners of the business at start-up. Equity is never repaid, unless the business is closed down and only in circumstances where there are sufficient funds from liquidation to return to the owners. While no regular interest payments are made to them, investors will hope to receive a dividend if the business performs well and is profitable.
- Debt financing – comes from a third party, external to the business. The loan must be repaid in full at the end of the loan period and interest payments are made on the loan amount. The lender gets their money back and is first in the queue if the business is made bankrupt, provided there are sufficient funds. One advantage of borrowing money in the form of debt is that, in the UK, currently the interest charged is deducted as an expense from sales revenues before taxation charges are calculated.
- Reinvested profits – come from the owners of the business but profits need to materialise as cash to be re-invested, or spent, in supporting the business.
Activity 1 Pros and cons of funding sources
Consider what the pros and cons to your business may be of equity financing, debt financing and reinvested profits.
How you finance your business will depend upon a number of factors like whether you are prepared to give away ownership of the business, whether you have expectations of high growth, whether you have a sales pipeline that looks healthy and whether you have a rapid turnover of sales and your customers pay you on time. There may well be other specific reasons to consider relevant to your business.
Next you will look at how to assess the cash flow of your business.