Introduction
Following on from our first article in this series of Starting a business we’ll look at money.
There are a couple of grounded principles when understanding money in business.
The first is that ‘business money’ is not the same as personal money. Aside from who owns the money they have totally different values.
The second is that access to money and having cash are two different things .
In this article, we’ll look into these points in more detail.
What is meant by Business Money?
When initially going self-employed for the first time, be it as a Sole Trader or a micro Limited Liability Company, many people see business money as an extension of their personal money, and this is a mistake.
Personal money is used to pay for living, whereas business money is a tool put to work to help the business operate and/or grow. Business money can be viewed as a screwdriver for an electrician or fuel for a delivery van; without either, it becomes difficult to operate.
Business money also has a different value from personal money. For example, you might buy an inkjet printer for printing the odd document or photo etc., for home use, and you might spend £150 on it. For business, though, you might want a laser printer that is faster, and cheaper per page, but it might cost £600.
The dearer printer is likely to be faster, more reliable and more efficient, and because it is tax deductible, might work out to be a better investment.
The customer is important, but cash is king.
The adage that the customer is king sounds great and one to tell the customer, but the reality is that cash is much more important. Without cash, you cannot service your customers, pay your bills, pay yourself or your staff.
In truth, you will likely need a mixture of cash and credit. If you need equipment, maybe a new machine, you could, if you have it, pay in cash, but there are tax benefits and cash flow benefits of using some kind of credit or finance deal to pay for the investment.
As an investment, cash is a poor tool. Dormant cash in the bank is decreasing in value daily, so it makes sense to use it, right? But, use too much, and you run the risk of being asset-rich but cash-poor, which is one reason many new businesses fail.
As with everything, choices bring compromises.
Look at the table below, and you’ll see that where small payments may be made with funding options, thereby enabling your business to invest in better, more expensive equipment, you will pay more in the long run and might lose control of the equipment. On the other hand, using cash eliminates both issues but might mean that you cannot afford to actually run the business!
Funding Options
| Funding Method | Pros | Cons |
| Cash | Your business owns the equipment No credit checks required |
Directly affects your cash flow If the business has yet to start trading you are using your own money |
| Credit Card | Instant and generally includes insurance | Probably the most expensive way to borrow money |
| Loan | Your business owns the equipment | May require a personal guarantee Possible obsolescence before the end of the term |
| Overdraft | Your business owns the equipment | Like a loan but at a higher interest rate More suited to very short term borrowing |
| HP | Small, fixed payments make budgeting simple Your business could buy the equipment at the end of the hire period with a ‘balloon payment’ |
More expensive in the longer term Your business could be at risk if you default on payments as the equipment may be seized by the lender Possible obsolescence before the end of the term |
| Asset Refinance | You’re buying a bit of the machine with every payment The equipment is the security for the loan Your business owns the equipment with the last payment |
The equipment needs to retain its value beyond the end of the term Possible obsolescence before the end of the term |
| Finance Lease | The lender owns the equipment and is responsible for its maintenance | There is no option to own the equipment at the end of the term Possible obsolescence before the end of the term |
| Equipment Lease | The lender owns the equipment, but you have the option to buy it at the end of the term via a ‘balloon payment’ | Restrictions may be applied as to the use of the equipment Upgrades and/or modifications to the equipment are not usually allowedPossible obsolescence before the end of the term |
| Business Grants | Free money and can increase your exposure | Applications for can be very specific (age/region/sector/etc.) and time-consuming Often require proof of work BEFORE you qualify Often only offer to match the sum that you put into the project |
Working Capital
As well as funding capital equipment, which may not apply to some businesses, you will certainly need operational cash (working capital).
Essentially, the cash that can be raised when needed, working capital can be seen as cash to pay your suppliers, put fuel in your vehicle, pay phone bills, pay subscriptions for web hosting, pay for business insurances, buy business cards, flyers, local advertising, etc. On top of this, you will also need to pay yourself, and any staff, and build a buffer to allow for dry periods… and they will come. You will need to make allowances for being off-sick or having family holidays [you will probably not qualify for SSP].
It is a truism that most startups cannot afford to cover their cash cycle from the beginning.
This is why I say that ‘Cash is King’… No cash = No business!
Types of access to cash
| Cash | Instantly available and costs nothing | The money lies dormant unless utilised and is not working FOR your business |
| Credit Card | Instant and generally includes insurance | Probably the most expensive way to borrow money |
| Bank Loan | Establishes a good credit line with your bank | Almost certainly requires a personal guarantee, often involving a charge on your house. |
| Overdraft | Useful if you generally have a positive balance in your current account. | Like a loan but at a higher interest rate More suited to very short-term borrowing |
| Peer-to-Peer Lending |
An initiative where the public becomes the lenders and earns a return on their capital. Lending rates are, generally better than high street banks. See Funding Circle as an example. |
Not suitable for startups. |
|
Invoice financing AKA Factoring |
Instant payment of your invoices upon presentation. Very good for positive cash flow. Debts and late payments do not affect your credit rating. Your accounts receivable are managed for you by the financing company. Repayment is taken from the money received from your customer. |
Some plans do not allow you to selectively use factoring, it is all or nothing. It can be difficult to put your business onto normal terms at a later date as you become dependent upon the cash flow. The financing company may refuse to provide credit to your customer. Typically more expensive than traditional borrowing. |
As you can see from the above, there are many options for financing your business. The skill is in:
- retaining enough cash to allow the business to trade
- investing in what the business NEEDS to grow
- being canny about the methods you’ll use to source the required funding
That’s business money. Let’s take a look at the next step… administration and core skills, in part 3
