Credit Tip Tuesday #39 - How to Finance Starting Your Own Business

THE BASICS: Firstly, finding the correct finance model for a small business is critical. If you borrow money from the incorrect place, you risk losing a piece of your business or being stuck with repayment terms that will stifle your growth for years. Debt financing is usually provided by a financial institution and works in the same way as a mortgage or car loan in that it requires regular monthly payments until the debt is paid off. In Equity Financing, a company or a person invests in your company. You don't have to pay back the money, but the investor now owns a portion of your company, possibly a controlling one. Don’t worry; we will dive into more details on these different kinds of financing later in the blog - so don’t quit reading!

Further there are three basic reports important to new business owners:

As it tells you precisely how funds are going in and out of business, the Cash Flow Statement is one of the most valuable financial planning tools. 

• The objective of a cash flow statement is to show what occurred to a company's cash during a specific time period, known as the accounting period. It displays an organization's ability to operate in the short and long term, based on the amount of cash coming in and out. It is typically broken into three sectors, operating, investing and financing activities.
• A company's cash from operating income should ideally surpass its net income on a regular basis, because positive cash flow indicates a company's ability to stay viable and expand its activities.
• Positive cash flow shows that a company's cash inflow exceeds its cash outflow during a given time period. Negative cash flow occurs when your cash outflow exceeds your cash intake during a given period, however, it does not always imply a loss of profit. Instead, a mismatch in expenditures and income may be the cause of negative cash flow.

Regardless of your position, learning how to read a cash flow statement and other financial papers will help you make better business and investing decisions.

A balance sheet is a financial snapshot of your business that shows all of your primary assets and liabilities.

• The balance sheet shows the overall assets of the organisation as well as how those assets are financed, whether through debt or stock. A statement of net worth or a statement of financial status are other terms for the same thing. The fundamental equation that the balance sheet is founded on is Assets = Liabilities + Equity. 
• Assets include current assets and long-term assets. Liabilities are money owed to others, such as regular costs, loan repayments, and other types of debt. Current and long-term obligations are the two types of liabilities. Rent, utilities, taxes, current payments toward long-term obligations, interest payments, and salary are all examples of current liabilities. Whereas, long-term liabilities include long-term loans, deferred income taxes, and liabilities owed to pension funds.
• As a result, the balance sheet is split into two parts (or sections). The balance sheet's left side lists all of a company's assets. The balance sheet shows the company's obligations and shareholders' equity on the right side. There are two types of assets and liabilities: current assets and liabilities and non-current (long-term) assets and liabilities.

An income statement, often known as a profit and loss statement, indicates where and how money enters and exits a business over time. Profit and Loss Statements indicate a company's financial soundness on a monthly, quarterly, and annual basis.

• The income statement presents the company's revenue, costs, gross profit, selling and administrative expenses, other expenses and income, taxes paid, and net profit in a logical and consistent manner.
• The financial statement is broken down into time segments that correspond to the company's operations. Although some firms employ a thirteen-period cycle, the most frequent periodic division is monthly (for internal reporting).

A profit and loss statement, a statement of operation, a statement of financial result or income, or an earnings statement are all terms used to describe the income statement.

Okay… but what is Debt Financing?

Debt financing is when a company sells debt instruments to individuals and/or institutional investors to fundraise for working capital or capital expenditures. Individuals or institutions become creditors in lieu of loaning money and acquire a guarantee that the principle and interest on the loan will be repaid. The lender has no control over the business's operations when it uses debt financing. Your association with the financial institution ends once you repay the debt.

Simple terms: Debt is when you borrow money from a bank or an investor under the terms of a contract that spells out how you'll repay them. Debt is regarded safer because it is contractually agreed that a corporation will pay its debts first (it has to).

What is Equity Financing?

The practice of obtaining funds through the selling of shares is known as equity financing. Companies seek money for a variety of reasons, including a pressing need to pay bills or a long-term aim that necessitates capital to invest in their expansion. A firm effectively sells ownership in its company in exchange for cash when it sells shares. While the word "equity finance" usually refers to the funding of publicly traded corporations, it can also refer to private company financing.

Simple terms: Simply put, equity equals assistance minus liabilities. As a result, equity refers to the portion of a corporation that is supported by the owners and/or shareholders. Equity is riskier because, while an equity owner can theoretically earn more money, payments (dividends) are not guaranteed.

There exist many similarities and differences between these two kinds of equity. 

Companies normally examine the following three variables when deciding whether to seek debt or equity financing:

1. What is the most convenient source of funding for the company?
2. What is the cash flow of the company?
3. How vital is it for the company's major owners to keep complete control?

What Funding is Right for Me?

The nature of your business primarily determines the type of funding you need. Consider taking out a loan from family, friends, or a bank if you're just beginning. If you are willing to give up a share of your firm as you grow and reach a broader market, equity investment may become a more attractive choice. Formal equity funding is difficult to come by, particularly for tiny, early-stage businesses. So often, you don’t necessarily have a choice. Debt finance is certainly your best, and possibly only, option if your firm is a startup serving a local market and does not require large-scale capital. To mitigate the risks of both types of funding, larger organizations frequently combine loan and equity financing.

We have put together a bullet-point list of useful financing tips for new business owners.

1.  Invest in Yourself

When beginning a company, your first investor should be you—either with your own money or with assets as collateral. This demonstrates to investors and bankers that you are committed to your project for the long term and willing to accept risks.

2.  Use Angels

Angel investors are typically rich individuals or retired executives who make direct investments in small businesses controlled by others. They are frequently industry leaders who provide not only their experience and network of contacts, but also their technical and/or management expertise. Angel investors are more likely to invest in the early phases of a firm.

3.  Count the Costs

You'll need to account for all of the costs associated with starting and running a firm. Your location, rent, supplies, marketing, and other costs should all be considered.

4.  Take Advantage of Government Grants and Subsidies

Government authorities may be able to help your company with funding in the form of grants and subsidies. On the Canada Business Network website, you may find a complete list of federal and provincial government initiatives.

5.  Don’t Put All Your Eggs in One Basket

Don't give up your day job just yet. It takes time to build a successful startup. Gradually shift from employee to entrepreneur by building your business in phases.

6.  It Pays to Have Friends

Remember that friends and family are there to support you. Many entrepreneurs raise money for their small firms by enlisting the help of friends and family. You can either approach your friends and family for an equity investment, in which case you are effectively selling them a piece of your firm, or you can ask for a business loan.

7.  Factoring

Factoring enables a company to get immediate capital or funds based on the expected future income associated with a specific amount owing on an account receivable or a business invoice. Accounts receivables are the funds owing to the company by its customers for credit sales.

Overall,  there are a multitude of ways individuals can help the financing of their start-up. As a fin-tech startup, Plastk understands the trials and tribulations of what it's like to get started, so we are delighted to offer our readers some of our newfound insight. Please feel free to let us know over our social media channels if this advice worked for you.

Disclaimer: The content provided on the Plastk Financial Inc. Blog is information to help Canadians become financially literate and learn about credit. Plastk is not responsible for building or ruining an individual's credit score or credit rating. It is neither tax nor legal advice, is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. Tax, investment, credit inquiries, and all other decisions should be made, as appropriate, only with guidance from a qualified professional.