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| Stack of cash. FBI BFO |
The
concept of using other people’s money to create wealth might sound like
fraud and myopic to a large extent. Paradoxically, being in debt is the
only way to real financial freedom. Being in debt is simply using money
that does not belong to you.
For a business to grow, it needs additional capital which, in most cases cannot be raised from its own coffers. In order to raise that kind of capital, business managers turn to external sources for financing.
It has to be said - from the outset - that debt financing is not the only way to raise additional capital. Another means of achieving the same goal is to relinquish part ownership of the business entity (equity financing) to investors in exchange for their money.
Inviting outsiders to co-own your business means that you will lose control in running it. Decisions that you make have to be vetted by the new owners. The process of decision-making becomes slow since you have to consult with your investors at every turn. The co-owners will also share your profits, hence the rewards become less motivating.
However, equity financing has its upside too. You are under no obligation whatsoever to repay the money raised from letting other people acquire a share of your business. The investors expect that the business will grow in value and from that they can make capital gains by selling off their shares. However, the business might not grow and the value of their shares may well diminish. This is the risk that investors must take.
Given the nature of the two forms of financing, you may be tempted to give priority to equity over debt financing. Many financial advisers prescribe an optimal mix of both. However, documented evidence has it that a business can grow on debt alone but no business can thrive solely on equity.
Debt in the form of long-term and short-term loans can be sourced from various quarters ranging from friends and relatives, to established financial institutions.
Before you approach your bank for a loan, bear in mind that borrowing means that you have to repay. Lenders will also charge you a premium in the form of interest on the funds they advance. This is the cost of borrowing and it is determined by the opportunities that the lenders have to forgo as they make the money available to you.
To get people to trust you with their money you have to show the ability to repay it. Banks, for instance, require you to present your cash flow projections for a given period of time... mainly the duration of the loan. Similarly, you will be required to secure your commitment to repay by submitting an asset, equal or higher in value than the loan, as collateral.
Once you enter into a legal agreement with the lender, you have an obligation to meet their demands but the liability is limited only to the duration of the debt. Upon repaying your loan fully, you will regain control of your business.
The difference between success and failure is determined by your decision to borrow. In order to make a wise decision bear in mind that debt should be adopted specifically to aid growth. Therefore before you decide to borrow, make sure that the business is in good health. This is because acquiring debt to bolster your cash account is a recipe for failure.
Borrowed funds do not constitute cash flow from operations. If your business cannot generate revenues, do not borrow to make up for this shortcoming.
Never exaggerate borrowing. The reason why you should ask for just what you need is that extra funds normally lead to impulse spending in non income-generating activities. Borrowed funds should generate enough to pay the interest charged on the loan. If you have to look to other sources to repay the loan then avoid borrowing.
Banks and other financial institutions also offer overdraft facilities. This form of debt financing helps businesses to deal with constraints arising from failure by customers to pay their debts in good time. Overdrafts are short-term in nature. They are also less costly in terms of interest and the conditions attached are not as strenuous.
Finally, as you plan for debt financing it is important that you exercise objectivity. This means that you should create room for contingencies. Ensure that the borrowed funds go only into the intended purposes. As much as being optimistic is good during planning, being negative is encouraged in order to see a clearer picture.
Cover Credit: Takk
For a business to grow, it needs additional capital which, in most cases cannot be raised from its own coffers. In order to raise that kind of capital, business managers turn to external sources for financing.
It has to be said - from the outset - that debt financing is not the only way to raise additional capital. Another means of achieving the same goal is to relinquish part ownership of the business entity (equity financing) to investors in exchange for their money.
Inviting outsiders to co-own your business means that you will lose control in running it. Decisions that you make have to be vetted by the new owners. The process of decision-making becomes slow since you have to consult with your investors at every turn. The co-owners will also share your profits, hence the rewards become less motivating.
However, equity financing has its upside too. You are under no obligation whatsoever to repay the money raised from letting other people acquire a share of your business. The investors expect that the business will grow in value and from that they can make capital gains by selling off their shares. However, the business might not grow and the value of their shares may well diminish. This is the risk that investors must take.
Given the nature of the two forms of financing, you may be tempted to give priority to equity over debt financing. Many financial advisers prescribe an optimal mix of both. However, documented evidence has it that a business can grow on debt alone but no business can thrive solely on equity.
Debt in the form of long-term and short-term loans can be sourced from various quarters ranging from friends and relatives, to established financial institutions.
Before you approach your bank for a loan, bear in mind that borrowing means that you have to repay. Lenders will also charge you a premium in the form of interest on the funds they advance. This is the cost of borrowing and it is determined by the opportunities that the lenders have to forgo as they make the money available to you.
To get people to trust you with their money you have to show the ability to repay it. Banks, for instance, require you to present your cash flow projections for a given period of time... mainly the duration of the loan. Similarly, you will be required to secure your commitment to repay by submitting an asset, equal or higher in value than the loan, as collateral.
Once you enter into a legal agreement with the lender, you have an obligation to meet their demands but the liability is limited only to the duration of the debt. Upon repaying your loan fully, you will regain control of your business.
The difference between success and failure is determined by your decision to borrow. In order to make a wise decision bear in mind that debt should be adopted specifically to aid growth. Therefore before you decide to borrow, make sure that the business is in good health. This is because acquiring debt to bolster your cash account is a recipe for failure.
Borrowed funds do not constitute cash flow from operations. If your business cannot generate revenues, do not borrow to make up for this shortcoming.
Never exaggerate borrowing. The reason why you should ask for just what you need is that extra funds normally lead to impulse spending in non income-generating activities. Borrowed funds should generate enough to pay the interest charged on the loan. If you have to look to other sources to repay the loan then avoid borrowing.
Banks and other financial institutions also offer overdraft facilities. This form of debt financing helps businesses to deal with constraints arising from failure by customers to pay their debts in good time. Overdrafts are short-term in nature. They are also less costly in terms of interest and the conditions attached are not as strenuous.
Finally, as you plan for debt financing it is important that you exercise objectivity. This means that you should create room for contingencies. Ensure that the borrowed funds go only into the intended purposes. As much as being optimistic is good during planning, being negative is encouraged in order to see a clearer picture.
Cover Credit: Takk
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