Sources of Finance Available to Small Businesses.
There are various sources of finance available to small businesses in order to finance their operations in addition to the initial capital needed to kick start the small business. After business owners must have started their businesses, other sources of finance will start to emerge. These include the following:
Overdraft on the other hand is a short term credit facility which is meant to meet short term financing requirements. The bank allows you to draw above what you have in your current account. The interest is normally payable on the amount overdrawn. Overdraft can be used to finance purchase of inventories. It is strongly advised that overdraft should not be used to finance projects that require long time before they start generating cash flow. Overdraft is used to provide a cushion during seasonal fluctuations in cash flow. This financing option may not be available to new small businesses as banks only grant overdraft to businesses that are having current account with them.
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If you are awarded a contract by a reputable organization and it is backed up by Local Purchase Order but you don’t have cash for the execution of the project, you can approach financial institution to finance the project. The financial institution will carry out its own due diligence to confirm that the Local Purchase Order is genuine. The financier may insist on domiciliation of payment or may require to be granted authority to pick cheque by any of their representatives. This serves as a safeguard to ensure that the funds are not diverted when eventually paid. Some financial institutions may also take up the responsibility of disbursing the funds to the suppliers from which you buy materials for the execution of the project. This, of course, limits your control over the fund. The important thing is that the money is made available for the execution of the project.
Entrepreneurs have to be creative in generating funds for their small businesses. Small business owners can actually transact businesses even when cash is not available. The fact that you have cash shortage should not mean that all things have to be grounded. Trade credits can help you keep businesses running in a period of liquidity crisis. It is a way of buying now and paying later. Generally, trade credits are allowed for a period of thirty days. Although cash discount may be lost, it is a good short term source of finance. You don’t pay any interest if the money is paid within agreed period. You need to carefully manage your cash flow to ensure that money is available when the debt is due to be paid.
Advance Payments from Customers
This is one of the secrets of multi-national companies in managing cash flows. They leverage on customer deposits in financing their operations. For a small business, if your product or service allows you to request deposits from customers, it is good to take advantage of this.
Situations may arise whereby your customers don’t pay you on time for the job you have expended cash to complete. This will put you in a very tight cash flow condition. In this type of situation, invoice discounting can be your option. Invoice discounting allows small businesses to draw money against their sales invoices before the customers actually pay. The financial institution will loan you a certain percentage of the invoice value. The invoice will serve as collateral. Therefore, when the customer eventually pays, the proceeds from the invoice will be used to offset the loan. You will pay interest on the amount you borrow. Not all invoices can qualify for invoice discounting. Finance companies may not consider the following for invoice discounting:
- Small value invoices
- Invoices from customers considered to be credit risks
- Invoices on sales to overseas
- Invoices with very long credit term
As your small business starts making profits, you can plough back the profits into the business instead of distributing it as dividends. Ploughing back profits can be a good way of raising funds for small businesses that are being debt constrained. No lenders like to put their money in a business that is carrying excessive debts, that is, a business with high debt to equity ratio.
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This source of finance could be used to finance the capital projects as you are not under any obligation to make repayment. It is also free from fixed interest burden. Since retained profits serve as internal source of finance, there is no dilution of control and ownership as in the case when you raise funds from additional partners.