After all the planning and preparation that has gone into your business, you think you’re in the clear once you turn a profit. While business owners traditionally evaluate a company’s financial performance based on net income, your continued efforts to generate new sales and trim costs might not be enough to save you from financial disaster. Profits are important, but cash flow is key in determining your company’s viability.
Profitability and cash flow are not the same and poor cash management is the top reason most businesses fail. Without proper cash flow, you won’t have the resources to pay your bills or your employees - the fast track to going out of business. Think your business is safe? While there’s no guarantee, keeping these factors in mind will help to manage your cash flow and sustain your business when times are lean. (For more, see: Asset Protection for the Business Owner.)
Self Financing Cash Flow
As a business owner, you put everything on the line to grow your business. Self-financing your startup can seem like the formula for immediate success. After all, you won’t have to deal with banks or investors. Plus, when your own money is on the line, you’ll look at your business differently than if you had borrowed it.
The truth is, while half of all businesses survive five years, most won’t make it to the 10-year mark. When cash flow stalls, it’s tempting to dip into funds earmarked for personal goals. This is especially true if you self financed your startup because you won’t have the necessary outside financial resources to lean on for your business. But doing so increases personal debt and your risk of bankruptcy.
For long-term success, avoid using your personal savings account or personal credit cards and lines of credit to supplement your cash availability. Mixing your personal finances may seem straightforward now, but you’ll pay the price later. Keeping separate bank and credit accounts for your business gives you a more accurate picture of the financial health of your business, and it also helps shield your credit score if your business takes an unfortunate downturn.
Financing Cash Flow
When cash flow becomes a problem for your business, it’s best to look at outside funding options. Whether it’s for growth opportunities like opening a new location, increasing inventory in anticipation of a busy season, or for supplementary cash flow, an estimated 99.95% of small business owners seek debt financing.
Traditional banks offer larger loans at a lower APR, but the application process can take months. Unsecured loans will get you money faster, though lenders will limit the amount you can borrow and your APR will likely be very high. That’s why, when it comes to financing cash flow, a cash flow loan is a good balance between the application process time and the cost of APR. (For more, see: Six Steps to a Better Business Budget.)
Here’s a look at the five most common types for your business:
Business Credit Cards
Using a business credit card is a popular option because of the relatively easy access to securing funding. Higher APR and lower borrowing limits make it an impractical option to cover large cash flow gaps. But if you’re a new business, need short-term purchasing power, and can pay it back in full within a month or two, this could be a good option.
Lines of Credit
Though similar to a credit card, lines of credit require a more formal agreement between borrower and lender. A line of credit is great for small business owners because it gives rolling access to cover seasonal cash flow gaps and can help to cover large cash payments to suppliers, vendors and contractors that don’t accept payments by credit card.
Similar in structure to a mortgage or car loan, a term loan for business lets you borrow a lump sum upfront and pay it back according to a fixed payment schedule. Most term loans require a business to have operated two years or more, a personal credit score of at least 640, and a minimum $200,000 in annual sales, making term loans a good choice for established small businesses.
Invoice financing lets you borrow money by managing your accounts receivable to cover gaps in cash flow. This is especially useful if you land a larger contract and need help coming up with cash up front to meet the large order. If you have a long history of credit sales and can collect within 60 to 90 days the majority of accounts receivable, this might be a good option.
Merchant Cash Advance
While not a loan, a merchant cash advance offers advance payment using your business’ future income as collateral. Terms can range from 90 days to 18 months and are repaid automatically using a percentage of your daily credit card receipts. This option is ideal for small businesses that lack a strong business credit score, though you must readily demonstrate a steady cash inflow stream to qualify.
Selecting the best way to finance cash flow is a complicated decision. You’ll need to understand your business’ finances in-depth to know if using a credit card, line of credit, merchant cash advance, or another method is right for you. While no one knows your business better than you do, a fee-based financial planner can help determine what financing options may make the most sense for your business. (For more from this author, see: Exit Strategies for Business Owners.)
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