Top 6 mistakes small businesses make when considering finance
If you’re setting up or running a small business, you’ll probably need to think about finance at some point.
There are many reasons you might need some extra funding – to buy essential equipment, pursue an exciting growth opportunity, or just to cover day-to-day fluctuations in your cash flow.
Seeking finance is a common step for many business owners, and with the right strategy and advice it can be less difficult to secure than you might think. But there are some important pitfalls to avoid.
Here are the top 6 mistakes to avoid when you’re considering finance for your small business.
1 – Failing to plan
As the old adage goes, ‘failing to plan is planning to fail’.
Securing finance can take time. If you don’t plan ahead for your financing needs you could find yourself caught short of cash while you’re waiting for a loan approval – or scrambling for finance at any price, which could leave you locked into an arrangement with high costs and restrictive conditions.
Make sure you allow yourself the time to prepare properly, including:
- Assembling your background documentation – financial records, strategic plan, business case and financial projections
- Creating a balanced financing strategy based on realistic projections of your short, medium and long-term funding needs.
It’s a very good idea to seek professional advice from an accountant or financial planner during the planning stage.
2 – Choosing the wrong sort of finance
The number one rule of business finance is to make sure that the type and term of your funding matches your business requirements. It’s absolutely critical that you don’t rely on a short-term facility such as a business credit card to finance major purchases that will take you a long time to pay off. Not only can you expect to pay hefty compound interest charges, you’ll also run the serious risk of being left in the lurch should your lender decide to withdraw your facility without warning (as is their right).
Meanwhile, long-term funding like secured loans should never be used to cover short-term needs, since you could get stuck paying interest long after you no longer need the facility – or be forced to pay a penalty fee to repay it early.
And when it comes to business finance, it’s not just a simple choice between short- and long-term loans. There are many possible sources of funding for Australian SMEs, including angel investment, peer-to-peer investment, vendor financing and crowdfunding.
Each option has its pros and cons. For example, getting angel investor involved means no debts hanging over your head, and angels often have a wealth of business knowledge plus valuable networks of contacts to offer. However, an investor will share both ownership and control, so it’s important to find someone who shares your goals and vision, and whose skills complement your own.
Again, it’s wise to seek professional advice to help you evaluate your options.
3 – Not researching the loan market
There are a lot more options than the traditional bank loan when it comes to business lending. In fact, there are at least 10 business loan options to consider.
If you decide to opt for debt finance, there are plenty of lenders to choose from, both traditional and alternative.
Your instinct may be to turn straight to your bank, and if you have a well-established business and plenty of time on your hands, that could well be the most cost-effective option.
But many small businesses simply don’t meet the conservative lending criteria of the big banks, and you need to be wary of applying for loans if you’re likely to be rejected, or you could end up damaging your credit rating.
What’s more, the banks’ application processes tend to be slow and cumbersome, so if you need a fast answer, you may have to turn elsewhere.
The ‘fintech’ market offers a more accessible, and usually faster, source of business finance for many SMEs. But be aware that alternative lenders don’t operate under the same regulations as Australia’s banks, so it’s important to do your research.
Take the time to understand the requirements and risk profile of each potential lender, and to research in detail the full cost, terms and conditions of the products on offer before making your choice.
4 – Not monitoring your performance
Compiling financial statements and financial projections is an important part of the planning process – but monitoring your financial performance also critical to meeting the ongoing financial needs of your business.
After all, if you don’t know how much money you are really making, where your cash is going and whether you have enough cash on hand to meet your upcoming obligations, you could be on the fast-track to financial ruin. Cash flow woes are the top reason businesses fail, and even the biggest household names (think Dick Smith) sometimes go spectacularly bust if they don’t keep tight control over their finances.
To avoid joining them, you’ll need to conduct a regular, detailed review of your financial performance. If finance isn’t your forte make sure there’s someone on your team with those skills, and perform a detailed analysis at least once a month.
This process is essential, so that you’ll have an accurate and up-to-date picture of which parts of your business are generating or draining money, where you are stretched to your limits and where you may have additional capacity to serve more customers.
Without this information, it’s impossible to make informed decisions about your business, potential growth opportunities, and your need – and capacity – to seek and service finance.
5 – Prioritising growth over cash flow
In today’s thriving online loan market, it may be quick and easy to secure the finance you need to grow your business. But just because you can borrow money, that doesn’t mean you should.
Unfortunately, not every growth opportunity is worth pursuing. If you’ll need to make a hefty upfront investment in labour, equipment or materials (which, presumably, is why you’re considering finance), there’s a real risk that the extra costs of servicing your new clients will outweigh the benefits (especially if interest rates rise and your loan repayments increase).
The fact is that turnover means nothing if it doesn’t translate first into profits, and then into hard cash in your bank. So rather than borrowing hard so you can chase sales growth, it’s prudent to focus on slow, steady growth that you can finance out of your existing profits – and to delay discretionary investment (for example, moving into your own premises) until you can fund it without borrowing. One of the main reasons small businesses fail is due to poor management of cashflow.
6 – Not having enough working capital
It could be argued that the most important asset your business has is its working capital. This is the pool of funds you’ll draw on to meet your regular ongoing expenses (wages, stock and materials, utilities, insurance, tax, etc), and it’s the lifeblood of your business.
As part of your financing strategy you may consider setting up a short-term, at-call facility to use as a working capital buffer. These aren’t the cheapest form of finance – you’re paying for convenience, so you’ll probably be charged a facility fee to access an overdraft or credit card, and the interest rates are generally much higher than long-term loans.
However, you’ll only pay interest on the amount of funds you draw down (generally calculated daily but paid monthly) and this kind of finance can give you the backup you need to help you ride out slow sales periods, or deal with unforeseen disasters.