Capital Structuring for Small Businesses (Part 2 of 3)

In my last post, I said there were several ways of financing your small business. I described how debt works in very basic terms. If you want more specifics on what sort of debt load your business can handle, you should talk your bank, credit union, or accountant to get some ideas on what exactly you're looking at.

Finance Option #2 Stock

The second flavor of financing your small business would be getting outside investors to give money to your business. To give you an idea what this looks like, just go watch the show "Shark Tank." The show's about small business owners and inventors who have an existing business or have some new invention that they need capital to be able to expand operations or start production. Some of the questions that the investor board asks may be some of the questions that you'll face when pitching your business. I will be honest, I haven't gone this route, because I want to have control over my business and how it operates. I don't want someone else telling my how my business is going to be run, or potentially edging me out of it. That being said, the three most important things in accounting and business are document, document, document! If you get an outside investor, make sure you clearly line out who does what and who has what rights over operations, business decisions, etc. Is the investor a "silent partner" meaning they don't have anything to do with the day-to-day operations and only worry about getting a cut of the business profits? What sort of reporting does the investor require? You definitely need to communicate those needs with your accountant, and if you don't have an accountant, get one! I say this, because when tax time comes, both you and your investor will be very interested in the forms that are filed with federal and state tax authorities.

From a very fundamental standpoint, outside investment may be necessary in the short-term. You also need to take the long-term effects into account as well. Generally, in accepting someone's financial backing, you'll be giving up a percentage of the business's profits. Make sure you take that cost into account as well.

For some of the same reasons I described in my last post, I have avoided having a family member as an investor just because I don’t want the potential fallout from something going wrong. I’d rather not thanks.

All these are important considerations to take into account when forming your small business, and determining the risk/return relationship in financing your business. In the next blog post, we'll discuss bootstrapping your business finances.

Financing your business

Money does grow on trees, you just have to pick it—Capital Structuring for Small Businesses

Capital Structuring for Small Businesses. (Part 1 of 3)

Capital Structuring. Sounds scary and complex, doesn't it? After all, you might be thinking, don't we just need money in the bank and everything will be OK? Not if you want to maximize your business's potential. I'm not a fan of personal debt; I do generally lean into the Dave Ramsey camp, but debt properly used in and for a business (note I didn't say for you personally) can unlock great potential for you as a beginning small business owner. In starting my own business, I have a credit line with the bank that allows me some liquidity (ability to pay bills later while making sales now) that I will probably have to dip into in order to finance larger projects or expansion.

Finance Option #1 Debt

This is pretty self-explanatory, but I'll go through the basics. Someone (usually a bank or a credit union) lends you money (a loan) or sets up a line of credit (think credit card). The loan is amortized, (root word meaning "put to death." Pleasant, huh?) or paid back over a certain period of time. You’ll usually have fixed monthly payments that will pay back part interest (the fee the lender charges for their money) and principle (the part of the loan that you're paying back.) In the beginning, the payments are mostly interest, but toward the end, you're paying more on principle than interest and the debt gets smaller faster. Your personal credit score or your business's financial clout determines the interest rate that you'll pay back to the lender.

In contrast, a line of credit just sits there until you borrow money from it, and then the lender calculates the payments you pay based on the amount borrowed. One other financing source you could look at would be borrowing from friends and family. One caution (and the reason I haven’t done this) is that if something goes wrong, all of a sudden Thanksgiving dinner is very awkward or your friend is no longer much of a friend anymore besides all the legal stuff you've had to wade through. I like family at arm’s length. It’s a comfortable distance.

Here are some helpful websites that will help you calculate how much a payment would be for a given time period and interest rate.

If you have more questions on what sort of debt your business can handle, then please talk to your bank, credit union, accountant, or shoot us an email at info@ledgerandpen.com.

There are ways to finance your business other than debt. We'll examine other forms of financing your small business in my next blog posts. 

Why do you need Accounting?

How do you know how your business is doing? I mean do you really know how your business is doing? Is there enough cash in your account? Will it be enough to get you through the next year, month, or week? Are you able to turn credit sales into cash? Is the debt you have for the business working as hard as it needs to in order to grow your business? What do we owe for taxes? These are the questions that can be answered by understanding what accounting is and how it works.

Balancing Act—Examining the Balance Sheet

The Balance Sheet is basically what you own or are owed (assets) minus what you owe (liabilities) with the leftover being your net worth of the business (owner’s equity). The bread and butter of how your company is structured is found on your balance sheet. For analysis, you can compare your balance sheet now to last year’s your balance sheet and see what’s changed. Has cash on hand gone up or down?  Have liabilities gone up? All these questions are the beginning of financial analysis, or the art/science of seeing how a business is performing. If you’re a small business owner, you really, really want to pay attention to your balance sheet. Any wide fluctuations from a previous period should make you question what’s going on. Also, there are two lines in the owner’s equity section, one is Retained Earnings and the other is Current Earnings. The Current Earnings are what you've made or lost this year and should match your year-to-date total on the Income Statement, and the Retained Earnings are your net income or loss from prior years. Pretty cool, right? It all interacts in a big circle.

Easy (In)come, easy go—How much did we make on our Income Statement?

The Income Statement is a much easier statement to grasp than the Balance Sheet. For one, it makes perfect sense. We had $10 million in sales; the inventory we sold cost us $2 million; there were $5 million of expenses, so we had a net income of $3 million. Pretty intuitive, right? It is, and one great way to use your Income Statement is to see how well your business is performing against a budget you (hopefully) wrote before the beginning of the fiscal year. If you don’t have a budget, make one J Life will improve drastically for you, because you will be able to see line by line how much you think you would make and spend based on your income and expense history, versus what’s going on now. If there’s a wide variance (good or bad), it’s time to start digging.

Hmm, my checkbook is thinner—The Statement of Cash Flows

Probably the hardest statement to understand is the Statement of Cash Flows. It doesn't help that there are a couple of different ways of putting the darn thing together, either. So, in short, the Statement of Cash Flows takes your accrual-basis books and makes it like it was on cash-basis. If your books are cash-basis (most small businesses are), then your income statement is like a statement of cash flows. But, for you accrual folks out there (that is, most of the world), there are three basic transaction categories that all transactions fall into, Operations, Financing, and Investing. Operations is what your business normally does. If you sell boxes, then the cash generated from the selling of boxes is an Operating activity. Say you need to sell stock in your business to take it to the next level. The cash generated from selling stock and paying your stockholders dividends is a Financing activity since you’re—you guessed it—financing your business. Also paying interest on debt falls into the Financing activities. The last category on the Statement of Cash Flows is the Investing activity section. This is where you put cash laid out for things like investments in equipment and building for your business. Also you would put cash generated by investments that you've parked your business capital in like stocks or bonds. The awesome thing about that Statement of Cash Flows is that at the very bottom you have cash at the beginning of the period, and cash at the end of the period, with the difference being all the pluses and minuses of each line in the Statement. Pretty cool, right?