The average entrepreneur does not have a comfortable understanding of finance. This allows them to miss opportunities to save money, streamline processes, and raise capital. In addition, it sometimes means that they don’t optimise the capital structure of their businesses to maximise their returns. Understanding finance is crucial for an entrepreneur to understand how to fund your dreams.
A solid understanding of finance is essential for any entrepreneur looking to scale their business. From sound financial controls to effective financial management, finance is the cornerstone of any company. Many successful startups have failed because they run out of cash. Timing differences between income and expenses can literally sink a small firm. Understanding these nuances can save you much stress and ultimately your business.
Funding Your Dreams – Key Finance Elements
There are a few key financial elements any entrepreneur needs to know:
- What is their cost of funding
Cost of sales and profit margin
- What are their debtor and creditor days
Which of their costs are variable and which are fixed (i.e. which costs increase with sales and which are there regardless of profit)
What is their optimal capital structure to maximise their return
What is their actual cash flow situation, and not just their profit (profit is an accounting figure that can equate to no cash in the bank)
Many entrepreneurs fall into the cash trap – assuming that profit equals cash which means they can easily pay their suppliers and their bills. This isn’t true, and many entrepreneurs with growing business actually run out of cash for this reason!
This is because as they grow their costs grow (together with their sales/profits hopefully!).
But, where they might allow their clients to pay them within 40 – 60 days of invoice (or some clients may just pay late), their suppliers require them to pay within 30 days of invoice or less. This leaves them with no cash, and suppliers start questioning their supply terms. In the meantime, some clients may even default or take much longer than expected to pay, leaving the cash situation even worse. No business can continue in this manner for long.
For this reason, many business owners, especially small ones, preach that cash is king! You can only pay your rent, electricity and suppliers with cash and not with profit which may or may not materialize. Credit is a dirty word to small businesses.
Funding Your Dreams
This is just one crucially important financial aspect of running a business. Other important considerations arise when an entrepreneur wishes to expand their burgeoning venture – they will need capital to do so. This capital will either come from debt or equity, and the relative cost of each is important in order to optimize the capital or funding structure. Obtaining equity may come with no fixed terms, but incoming shareholders may want large equity percentages or certain rights which may even prevent the company from obtaining debt.
An entrepreneur may also want to start extracting profit from the business. Should this be done in the form of shareholder loan repayments or dividends? This will have an effect on the tax the business and the owner pays.
As you can see, there are countless elements to consider and this is why an astute CFO is
critical for a business of any size. A CFO will guide the CEO or owner on these decisions. When lacking a good CFO, one can also obtain the input of a good financial advisor.
Self Funding is the Best Funding
To summarise, may we impart one piece of advice: stay self-funded for as long as possible! Both debt and equity will come with certain terms and conditions, and an entrepreneur focused on the growth of their business should not worry about such things that could distract them from their main aim.
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Good luck and happy financial modelling!