Small business finance is a term used to describe the broad range of activities related to managing money of a business.  Business owners (sometimes hereinafter referred to as “Owners“) should have at least a basic understanding of these concepts, as they are vitally important to the success (or failure) of a small business.  After all, cash is the most valuable resource of a small business, and positive cash flow is the life blood sustaining its future.

Given the direct correlation between positive cash flow and small business success, owners should define the capital structure of their company, manage cash flow with caution and close attention to detail, build personal/business credit efficiently, and familiarize themselves with the requirements for obtaining a small business loan.

Defining the Capital Structure of a Small Business

As mentioned above, managing the finances of a small business requires careful planning.  The importance of this process cannot be overstated, and it should begin prior to a firm’s opening.  The first step in the planning process is to define capital structure.

The purpose of defining capital structure is to identify the sources, amounts and availability of cash for use in your business.  Understanding the financial makeup in this regard is essential for maintaining cash reserves required to sustain operations, invest in the future, and finance long-term growth.

In general, there are two (2) types of capital available for financing a business, as follow:

1. Debt Capital – consists of funds borrowed from a lender to be repaid in accordance with contractual terms agreed upon by the parties, and
2. Equity Capital – refers to funds received in exchange for ownership stake in the business or contributed to the firm by existing owners.

It is important to point out that capital structure must be adjusted in response to changes within your business.  Likewise, it must evolve and change just as your firm adjusts to external market conditions.  As a business owner, you must maintain a pulse on the company to gauge impact from internal and external forces, because it is your responsibility to evaluate and tweak the capital structure in response to these occurrences.  As part of my year-end procedures, I evaluate prior-year performance (taking into consideration such internal & external stimuli as previously mentioned) and assess adjustments to my practice and the market as a whole.  Based on the information I discover from this analysis, as well as, the objectives I hope to achieve in the following year, I make capital structure adjustments as necessary/possible.

Cash Flow Management

In addition to the planning component described above, small business finance includes (i) accounting for the financial affairs of the company, (ii) reporting financial results from activities, and (iii) complying with applicable regulatory bodies.

For example, best practices for managing cash flows include the following:

• Utilizing accounting software (i.e., QuickBooks, Quicken, etc.) that can be synchronized with bank accounts (accounting), produce standard financial reports such as balance sheet, income statement, statement of cash flows, etc. (reporting), and easily share with CPA (compliance),
• Maintaining books and financial records in orderly fashion by recording daily cash receipts & disbursements, recording customer invoices with accurate dates and payment terms, entering vendor invoices upon receipt and using accurate payment terms, and reconciling bank accounts each month upon receipt of month-end bank statements (accounting),
• Routine (i.e., weekly) analysis of working capital by way of reviewing Aged Receivables and Unpaid Bills Detail.  Specifically, these reports should be used to identify outstanding receivables nearing delinquent status, accounts payable coming due, and potential shortfalls/surplus in working capital (reporting),
• Actual-to-Budget comparisons at scheduled intervals for the purpose of evaluating performance and identifying problem areas (reporting),
• Creation of a “rainy-day” cash reserve by way of incremental savings from improved cash management (compliance), and
• Opening a revolving line-of-credit after establishing a track-record of financial trustworthiness with primary bank (compliance).

Building Business Credit

Starting out, personal credit cards may be the only financing option available.  While this is a common means of bootstrapping, it is advisable to begin building credit in the name of your business ASAP in order to reduce risk exposure and open new lines of credit.  Follow the steps below to begin building business credit:

• Setup your business as a separate, legal entity by registering with secretary of state, IRS, etc.,
• Upon registering with applicable regulatory bodies, open bank account in business name (using business tax ID number, etc.),
• Register business with applicable trade organizations and/or professional organizations (i.e., BBB, Chamber of Commerce, LCPA, etc.),
• Register your company with credit bureaus, such as Dun & Bradstreet, Experian, etc.
• Request to open credit lines with vendors/suppliers and request to have payment history reported to credit bureaus,
• Apply for a credit card in the name of your business,
• In time, apply for a line-of-credit (revolving) with bank or other lending institution,
• Pay creditors timely and consistent with agreed-upon terms, &
• Monitor credit profile(s) regularly (similar to the way you monitor your personal credit profile) and resolve any disputed reports.

Additional Resource:

–How to Build Business Credit for Your Start-Up by Marco Carbajo

Applying For a Small Business Loan

Applying for a small business loan can be an intimidating process, but planning ahead can remove uncertainty and alleviate stress associated with the unknown.  On the other hand, failure to plan ahead and prepare standard documentation requirements can lead to submission of an incomplete application.  Landing yourself in this position almost assuredly guarantees a rejection of your request for credit, and it can also cost you valuable time that cannot be recouped.

The good news about applying for a small business loan is that documentation requirements among lenders are relatively standardized.  In other words, the majority of lending institutions require similar documentation to accompany loan applications.

In general, you will be required to submit the following information with your application for a small business loan:

• Business Plan & Loan Proposal,
• Tax Returns (previous two years),
• Financial Statements (most recent year),
• Authorization to Review Credit Report, &
• Personal Guarantee (by business owner)

Additional Resources:

–The Secret Weapon That Can Help You Get a Better Business Loan by Gerri Detweiler

–Ten Key Steps to Getting a Small Business Loan by Richard Harroch