Sources Of Funds

Written by Joe Driscoll

November 22, 2009

Does a business start with the product or the order? Which comes first the service or the customer? It’s the old chicken and the egg debate and there is probably no universally correct answer. Regardless of where you stand on which came first for a business, there is no disagreement that money is the lifeblood of all businesses. Without cash for working capital and financing for capital investment, no business will last for long.

At every stage in their life cycle, all businesses need to obtain capital at a reasonable cost. The need for capital is most pressing when starting a business or when managing the growth of an established business. You need to have an awareness of the various financing alternatives available and a solid understanding of the advantages of each alternative.

Funding sources can be divided into two major categories. First, internal funds are those sources of funds that can be found within the business itself. internally generated funds are the business owner’s most readily available source of low cost funds. Secondly, external funds are those sources of funds that are obtained from a wide variety of outside parties. External funding can be further be subdivided into two categories, debt financing and equity financing.

Lets take a look at internal sources of funds.. A closer look at debt financing, the sources and lending practices of local financial institutions, and equity financing, where to find investors and what they are looking for, will be subjects for future discussion.

When we begin to look for internal sources of funds, we begin on the asset side of the balance sheet. If you don’t have a balance sheet, make one. If you don’t know how, get some help from your accountant. Good management of even the smallest of businesses requires a regular review of assets and liabilities presented in a balance sheet format. The balance sheet is organized from top to bottom by the liquidity of your assets. Liquidity is the theoretical ease with which assets can be converted into cash. Since cash for growth is what we are looking for, let’s start at the top.

Assume a business with an annual sales volume of $600,000., an accounts receivable balance of $50,000. ranging from 30 to 45 days old and inventory of $30,000. An opportunity arises to purchase some new equipment that will improve profit margins and allow the company to increase volume by 50% over the next two years. To purchase the new equipment the business needs to make a cash down payment of $15,000. Where’s the extra cash going to come from?

Try spending an extra half hour a day on the phone following up on the receivables. Get those payments down to thirty days or less. Never underestimate the power of a personal telephone call when collecting payments. I am consistently amazed how this readily available source of funds and this extremely effective collection mechanism go unused in even the largest companies. All it requires is a little effort, tact and persistence.

If profit margins are acceptable and immediate cash availability is the priority, consider giving your customers an incentive for early payment. A wide variety of incentives can be effective. Use your imagination. Consider extra merchandise, increased service or discounts on future orders as well as the traditional cash discount. Don’t just type your early payment discount on the bottom of the invoice and expect the customer to take action. Just like any other special program, you will have to sell it if you want it to succeed. Get on the phone again, call your best customers and tell them about it. Send out a special notice with the next billing and announce it as a feature that will benefit both you and your customers.

Don’t overlook inventory when you need short term funds. While it will be difficult to reduce inventory as you look to expand your business, periodic inventory review will generally present some opportunities. Look first at excess items. Check with your suppliers to see if they can be returned. Don’t be bashful because the items are old, they might be just what your supplier requires to meet another customers needs. Also give thought to a direct sale of excess items, modifying designs to consume inventory and discounting slow moving items. Call your employees together and see if over the short run they can work with shorter lead times on supply items that will permit fewer purchases and a resulting temporary inventory reduction.

Use your imagination and you should be able to free up that needed $15,000 until other financing becomes available. Don’t overlook other potential sources of internal funds on that balance sheet. The sale of unused fixed assets or the renegotiation of supplier terms that will let you extend your payments may take a little more effort than managing the receivables and inventory, but they remain a fertile source for internal funding.

Conventional wisdom dictates that internal funding is not available to the entrepreneur just starting his business. Not true! Two major consumers of cash in a start-up business are rent and payroll.

Find a location that hasn’t been occupied for awhile and has thus not produced any recent revenue for the owners. Propose that in return for their deferring your rent for three months you will take a years lease and pay the back rent in full at the end of three months. You end up with an internally generated interest free loan that helps you meet your capital requirements and your landlord stands a good chance of having a full years lease on an otherwise unproductive asset.

Similar arrangements can lessen the cash drain of payroll costs at start up. Find employees that either have other sources of income and can “moonlite” for deferred wages or find individuals who are currently unemployed and will accept deferred payment for the promise of future employment.

Cash is the life blood of any business. Because “It’s Your Business”, remember to make a regular review of your balance sheet for sources of readily available internally generated funds.

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