Whether you are starting a new business or planning to expand your existing one, having the right form of finance is very crucial. It has a direct impact on your business operations and marks the difference between success and failure.
That being said, it is crucial for small business owners to know the financing options available to them for different purposes. Because in business, the circumstances never remain the same and funding solutions vary depending on the situation and requirements.
Here is a guide on different financing options available to small business owners and how each one can help you grow your business.
Traditional Term Loans
Nature: Long-term loan
A business term loan is also referred to as "vanilla commercial loan" and is a straightforward loan with no special features. Under this loan type, you borrow a fixed sum of money at a predetermined interest rate, tenure, and repayment interval.
Financial institutions classify traditional term loans into two categories:
Intermediate-term loans: The loan tenure in this category can go up to 36 months.
Long-term loans: The loans availed under this category have a very long repayment tenure, ranging from three to ten years. It can even go up to 20 years in certain cases depending on business requirements.
Who should opt for it?
A business term loan should be availed to meet long term requirements like purchasing new equipment, funding capital expenditure, etc.
The applicant of traditional term loans should have a good credit score and healthy cash flow to qualify for the loan.
Business Line of Credit
Nature: Short-term loan
A business line of credit offers flexibility to small businesses that regular business loans fail to provide. It is an unsecured line of credit and is a form of revolving credit, where businesses borrow against the available credit limit.
It provides businesses with easy access to funds to meet the short-term working capital requirements. Further, the interest is levied only on the sum borrowed, not on the sanctioned credit limit.
Who should opt for it?
As mentioned, it is best for meeting short-term requirements related to working capital needs including buying inventory, meeting seasonal cash flow issues, paying debt, or meeting any other business requirement. Loans offered under this category are relatively expensive; therefore, it is best to repay the loan amount quickly.
Machinery Loans
Nature: Long-term loan
Machinery loans are asset-based financing, specific only to the purchase of new and refurbished machinery. It comes with a long repayment tenure, which enables businesses to meet the cost of upgrading machinery without impacting their cash flow.
Who should opt for it?
Machinery loans are provided to only those business ventures which are dependent on machinery to generate sales and earn a profit. It provides capital for the purchase of specialized machinery and vehicles, computer systems etc.
Bill Discounting
Nature: Short-term loan
Bill discounting is also known as invoice financing and account receivables financing. It is a mode of finance where businesses trade their sales bill with a financial institution before its credit period ends. The value of the bill discounted is always less than its par value, which is dependent on the time left for its maturity and the risks associated.
This mode of payment is applicable only when the buyer has made payments to the seller through a letter of credit.
Who should opt for it?
Bill discounting helps free up tied capital, lowers working capital cycle and improves the cash flow position of your business. However, frequent use of bill discounting reduces profitability and impacts securing an additional source of finance.
Business Credit Cards
Nature: Short-term loan
Business credit cards are available to businesses of all sizes and is one of the easiest funding solutions for businesses. Being a revolving form of credit, it helps to build a credit profile and improves future credit terms.
Business credit cards are backed by a personal guarantee, which helps to set the terms of its usage and limit.
Who should opt for it?
It is a suitable mode of financing for those businesses which do not rely too much on credit for running operations but want to have access to a form of credit which can be used when required. The functioning of business credit cards is similar to personal credit cards.
Crowdfunding
Nature: Long-term loan
Crowdfunding is a new and alternative source of finance to help new projects and business ventures to raise capital. This is suitable for those who have limited access to traditional financing modes.
This mode of financing is extremely popular among small business entrepreneurs. The whole exercise is executed via an online platform. To raise capital through crowdfunding, you need to pitch your business idea and encourage people to invest in it.
Crowdfunding investment is of two types, equity and debt, where the former involves the transfer of equity shares in the exchange of money. And, in the latter, investors invest in the debt paper of the company.
Who should opt for it?
Crowdfunding is suitable for small projects, or entrepreneurs and projects having a futuristic vision. Entities opting for crowdfunding also need to undertake an extensive marketing campaign to attract investors to their project.
Merchant Cash Advance
Nature: Short-term loan
A merchant cash advance (MCA) is a lump sum advance to businesses against an agreed-upon percentage of future point of sales (PoS) transactions. This mode of finance is suitable for businesses, which register a good volume of card sales.
Unlike other loan types, which include interest rates, MCA does not have an interest rate, instead, it has a factor fee. For example, if the lender decides the factor fee at 1.3, then the borrower needs to repay the sum borrowed multiplied by factor fee.
Who should opt for it?
As discussed, it is suitable for business having steady sales from PoS transactions, especially for the retail and leisure sector.
Personal Savings
Using your personal savings is the easiest and most cost-effective mode of financing your business requirement. Further, it frees you from the obligation of repayment and gives you greater control over your business finances.
Who should opt for it?
Choosing personal savings for funding business growth is effective when the amount is small and you do not have a long credit history. But, for executing large plans, you need to leverage your balance sheet and opt for other financing options.
Just as having the right business strategy is important for achieving desired results, in the same way, choosing the right financing option is just as imperative.
Choosing the right financing option depends on a number of factors like balance sheet position, cash flow position, nature of requirements etc. Closely analysing the factors and funding solutions available, you can find out which small business financing option will work best for you. Thus, helping you to fuel the growth and meet the development goals of your company.
