Mastery in Business Finance for Essential Tips & Strategies

Every business venture, irrespective of its size and nature, requires funds to operate and grow. Business finance makes this possible. Whether you helm a sole proprietorship, belong to a partnership firm or manage the finances of a company, mastering the art of business finance is crucial for financial success.

This handy guide can help you understand what business financing is, how it works, the different types of loans you can choose from and more.

The Meaning of Business Finance

You may be wondering what is business finance and what is the importance of business finance.

The term business finance refers to the funds required to incorporate, operate and grow a business across its various stages. The art of managing business finance includes obtaining the required funds, allocating them for different purposes and ensuring they are repaid diligently.

Business and finance go hand in hand. Many businesses fail to sustain their operations simply because of poor business finance management. However, by understanding your options in this area and taking effective measures to handle business finance loans and funds, you can avoid this costly mistake and ensure your venture thrives over the years. Scope of business finance is very wide, read along to understand various sources of finance for businesses.

Various Sources of Finance for Businesses

For businesses there are various sources of finance. Business finance is primarily one of two types: equity finance and debt finance. Let’s examine these sources more closely.

Also Read: How to Get a Small Business Loan for a Startup

Equity Finance

This is a type of business finance where you raise funds by issuing shares in your company to external shareholders or investors. Each share represents a unit of ownership in the company. Since the shareholders contribute the funds in the capacity of investors and not lenders, your business need not repay these funds. However, the investors will have a share in the future profits of the business.

Equity financing can be obtained via different channels such as:

• Venture capital financing from investors for high-growth startups : In venture capital financing, venture capital funds pool money from the investors and invest the money in non publicly listed companies in exchange for ownership in the target company. Venture capital funds identify companies that are currently doing well and have a high growth trajectory and potential to generate massive returns over the years.
• Angel investing, where individual investors provide capital for early-stage companies : This type of investing is usually done by individual angel investors or firms set up by angel investors. The main goal is to identify bright spots in the industry, if the company has a great idea or business plan which if executed well can generate exponential returns, then these angel investors invest money during very early stages like ideation stage, or to set-up the business.
• Initial Public Offerings (IPOs), where companies offer shares to the public : IPO is a process by which the company gets listed officially on the stock exchange, i.e. the shares of the company gets listed for the investors to invest and trade. After the IPO process, the ownership of the company changes from a private company to a public company since the ownership is listed for the common people to buy.
• Private placement of shares to a select group of investors : By this process, the company can put forth a set number of shares representing ownership in the company to private investors. Private investors can buy the part ownership in the company in exchange for money consideration which can be used by the company for the purpose they deem fit.

Debt Finance

Debt finance is a type of business finance where you borrow funds from different lenders. Since the funds are obtained in the form of business finance loans, you will have to repay them as per the terms and conditions involved. The advantage of this kind of financing is that you retain full ownership of your business. On the other hand, you need to have an ironclad debt repayment strategy to ensure the business finance loans do not drain cash.

Debt finance can be of different types, as outlined below:

Term Loans

These are traditional loans where you borrow a lump sum of cash and repay it over a fixed period along with interest. They can be short-term (less than a year), medium-term (1-3 years) or long-term (more than 3 years).Term loans as the name suggests are loans that have a fixed repayment term, as outlined earlier it can be short, medium, or long term loans. During the course of loan the repayment of both interest as well as the principal is made by the borrower to the lender. Term finance is a great way to fund projects and repay over fixed terms.

MSME Loan (Micro, Small and Medium Enterprise Loan)

These business finance loans are specifically designed to provide MSME with the capital required to manage day-to-day expenses or expand their operations. They generally offer favorable terms like lower interest rates or relaxed eligibility criteria. These MSME loans have terms and conditions favorable for the borrowers. There are certain rules and regulations, and schemes by the government of India which enables the lenders, be it private or public lenders, to lend loans to MSME businesses easily. MSME businesses usually apply for loans for purposes like starting up the business, investing in infrastructure like plants and machinery, or to support working capital requirements.

Unsecured Business Loans

Unlike traditional loans that require collateral, unsecured business loans are provided based solely on the borrower’s creditworthiness. These loans are riskier for the lender, so they may have higher interest rates and stricter credit requirements. In lending businesses, the rule of thumb is that high risk translates into higher interest and unfavorable loan terms for the borrowers. Hence for risky loan assets, lenders sometimes ask for security in the form of collateral. Currently there are a wide range of lenders offering unsecured business loans to businesses with good credit history and slightly lower risk.

Working Capital Loans

Working capital loans as the name suggests are a type of business loans specifically designed to cater to business’ working capital requirements. These loans are usually short terms and are targeted towards flexible repayment to help businesses repay loans without hampering their business cycles. These are short-term loans intended to finance the everyday operations of a business. They are not used for long-term investments or purchases but are instead aimed at covering operational costs like rent, payroll and utility bills.

Lines of Credit

This is a flexible business finance loan where the lender provides access to a specific amount of funds. Your business can draw from this line of credit as needed, while still paying interest only on the amount used. How line of credit works is that, the businesses with a relationship with the lenders and have frequent debt requirements may apply for a line of credit. What the lender does is that they carve out a loan limit as per the requirements and the risk exposure, the borrower can withdraw any amount in the form of loan from that carved out limit without going through the hassle of applying for a fresh loan.

Equipment Loans:

Designed specifically for purchasing equipment, these loans use the equipment itself as collateral. This can be a more accessible option for businesses that might not qualify for other types of loans. Equipment loans as the name suggests are not by internal sources of finance. These loans finance an equipment for the business with terms and conditions which makes it a collateral which the lenders can seize and liquidate in case of default. But unlike traditional loans with collaterals, these equipment are possessed by the borrower and will continue to use and take benefits.

Invoice Financing/Factoring:

This type of business finance loan involves selling your unpaid invoices at a discount to a third party. The third party pays you most of the invoice value upfront and takes responsibility for collecting the payment from your customers.

Also Read: Perfect the Art of Getting Investment: 7 Essential Tips

Business Finance Insights: 5+ Key Things to Know Before You Borrow

To make the most of the business finance options available today, you need to be aware of certain key aspects before you borrow or raise funds for your venture. Here are some useful insights that can help you master the art of business finance.

Varied Financing Needs

Businesses require financing for various reasons like starting up, expanding their operations, managing cash flow and investing in equipment and technology. The purpose of financing often determines the most suitable type of funding.

Impact of Business Life Cycle

The stage of your business’s life cycle (start-up, growth, maturity or decline) significantly influences its financing options and strategies. Startups might rely more on equity financing and venture capital, while established businesses may have better access to loans and credit.

Risk and Return Trade-Off

In any business finance option, there’s a trade-off between risk and control. For instance, while equity financing doesn’t need to be repaid, it does dilute ownership and control. Debt financing, on the other hand, keeps the control with the owner but adds financial risk. So it is essential to gauge and understand the acceptable risk and return trade-off between signing off on any type of financing be it equity or debt. For equity finance, understand if giving up ownership and control over the part of the business is worth the financing that can be secured to run or expand the business. Similarly, for debt financing, it is imperative for the entrepreneur to make the call if the risk and return trade-off in terms of interest rates, loan repayment tenure, loan terms, etc is worth the opportunities that the financing will open the gates to.

Importance of Creditworthiness

The credit history of your business can greatly affect its ability to secure business finance loans. Lenders look at credit scores, financial health and repayment history to determine eligibility for financing. Maintaining a good credit score is crucial to obtaining favourable terms. Creditworthiness determines if you’re a risky borrower for the lenders, which ultimately helps the lenders decide on critical factors like interest rates, tenure, flexibility in repayment, debt terms and conditions, requirement of collateral to secure debt funding, etc. It is imperative for an individual as well as a business to maintain a good credit record. There are several ways, if followed, to ensure a good credit history.

The Role of Collateral

For many types of business finance loans, lenders require collateral in the form of assets like real estate, inventory or equipment. This provides security for the lender but leads to higher risk for your business if the loan cannot be repaid as due. Having a collateral backed loan may help you secure a cheaper debt funding with attractive financing terms and conditions. Collateral acts as a security to the lender that in case of default, the lender can recoup the money by liquidating the collateral asset given to the lender by the borrower. It is a great way to decrease risk for the lender, however the borrower would not be able to utilize the collateral during the term of the loan, as the same is in possession of the lender.

Impact of Market Conditions

Economic conditions and market trends can significantly influence investor confidence, the availability of financing and the interest rates on business finance loans. You need to be aware of these factors before applying for financing for your venture. Let’s first take an example for debt financing, if the market conditions are unfavorable to the lenders, securing favorable debt financing terms and conditions, low interest rates, and flexibility with repayments may be difficult. Similarly, for equity financing options, bad market conditions may impact on the valuation of the company as th4e market conditions have a waterfall effect on the company’s performance and the amount that investors would be willing to pay for the company directly affecting the valuation. Rising market conditions and wealth may have a positive impact on the businesses and vice versa.

Business Finance Strategies to Optimize Funding

To optimise the funding available for your business operations and expansion, it’s essential to have a solid business finance plan in place. The strategies outlined below can be useful in creating an effective funding plan.

Get the Details Right

A clear and detailed business plan is essential to secure financing. It should explain your business model, market analysis, revenue projections and long-term goals. This reassures lenders or investors about the viability of your business. Being able to understand and explain all the details of the business from broader information, like the market conditions, what you’re offering, what sets you apart, financial details, working capital, where you lie in the market, to the finer points which indicates the financial health of the company. The sustainability outlook of the business and what can be done to make it better, would help you massively with the investors to convince them to fund your business.

Build and Preserve Creditworthiness

Establish and maintain good credit because it’s vital in business finance loans. This involves repaying debts on time, managing credit lines wisely and monitoring your credit score. A strong credit history can improve your chances of securing financing with favourable terms. It is essential for an individual as well as a business to maintain a good credit record. There are several ways, if followed, to ensure a good credit history. Some of those tips are : Do your loan repayments on time, ensure you have a long standing credit history which can help you boost credit score, try to keep credit utilization under control i.e. the ratio credit taken to the credit available (It is advisable to keep it under 30%) make sure that your repayments are not dishonored . Have consistency in details. Having a long permanent address where you’ve taken credit loans may help you boost your credit record, albeit by a small margin.

Understand Your Financing Needs

Clearly define why you need business finance and quantify the funds your business requires. This helps you choose the most appropriate financing option and makes it easier to negotiate the terms and conditions. It is imperative to understand your business finance objectives , and accordingly set your financing needs and act upon them. Securing a finance for your business when you don’t actually need one could be disastrous for your working capital. Hence, it is essential to optimize the working capital and operations of your business which can help you understand objectives of business finance and secure necessary financing at a desirable interest rate.

Diversify Your Financing Sources

It’s never a smart idea to rely solely on a single source of financing. Explore a mix of options like loans, equity grants and alternative financing solutions. Diversifying your business finance sources can reduce risk and provide more flexibility. Having a single financing source may not be a very good idea, with different lenders you can negotiate the terms better and have a good mix of interest rates offered on certain debt financing. Let’s suppose an earlier loan was taken at a high interest rate, if you’re able to secure a future loan with substantially lower interest rate then it may help you set-off the higher rate that you’re paying for the earlier loan.

Negotiate Terms; Not Just the Rates

In addition to the interest rates, you must pay attention to other terms of business finance loans like prepayment penalties, repayment duration and the like. Negotiate these terms to align with your business’s capacity and growth plans.

Conclusion

These insights and strategies about business finance loans can be pivotal in the success of your business venture. Before you approach a lender and sign the dotted line, ensure that you understand the terms and conditions involved. This is crucial to your debt repayment strategy. Additionally, with many different sources of business finance easily available today, ensure that you choose the funding channel that’s optimal for the growth of your company or firm.

It’s also crucial to choose a trusted lender for your business finance loans. In this context, Lendingkart emerges as a credible option. Whether it’s unsecured financing or MSME loans you need, we’ve got you covered with a wide range of financing options. What’s more, you also get the benefit of superfast loan processing, quick and timely disbursals and fair interest rates.

Frequently Asked Questions

What are the business finance options available for small businesses?

Small businesses have various business finance options like traditional bank loans, lines of credit, microloans, MSME loans and working capital loans.

Which is better: equity finance or debt finance?

The choice between equity and debt finance depends on the specific needs and circumstances of your business. Each type of financing has its pros and cons.

Can startups obtain business finance?

Yes, startups can obtain business finance, though it’s often more challenging due to their lack of credit history. Common options include angel investors, venture capital, startup loans and working capital loans.

Is credit score important in business finance loans?

Yes, the credit score of a business is extremely important in business finance loans because it influences lenders’ decisions on loan approval, interest rates and other terms and conditions.