Financing and financial

management for small business

Financial management
Availability of money is key to success of the business -
turning business into viable financial venture
 a company cannot be viable unless it is successfully
financed
Entrepreneurs and those managing the firm must be aware
of how much money they have in the banks and if the
amount is sufficient to satisfy financial obligations
They need to ensure that the firm does not face financial
challenges and that the financial resources are used
optimally
 Financial management involves
Knowing where funds for business startup will come from
Seeing whether the firm is making or loosing money
Knowing how much cash is at hand
Knowing whether there is enough cash to meet the short
term obligations
Knowing whether the assets are being utilized effectively
Comparing growth and net profit with peers in the industry
Where the funds for capital improvement will come from
Finding out whether there ways to partner with other firms
to share risks
Overall is the firm in good shape (financially)
Financial objectives of a firm
1. Profitability – ability to earn profits over time
2. Liquidity
 ability to meet short term financial obligations ( keep
enough money in the bank to meet its routine
obligations in a timely manner)
 This requires keeping close watch over accounts
receivables and inventories - if this is too high, it
may not have enough cash to meet short term
obligations
3. efficiency
 How productively a firm utilizes its assets relative to its revenue
and its profits
4. Stability
 The strength and vigour of the firms overall financial position
which enable it;
 Not only to earn profits and
 Remain liquid but also
 Keep its debts in check
 The debt equity ratio must be checked in order to meet its
obligations and secure the level of financing needed to fuel
growth
Financing of small
business
Purpose of financing
To start a new business
To expand a existing business
To meet an emergency situation
To meet normal operating costs
Financing your business - importance
Your ability to raise the required funds is extremely
important factor in determining the type and size of
business you wish to enter

There is no one best method of financing and the

methods vary over time based on the
stage of development of your enterprise,
the economic environment and
 legal environment
Stages in business development
Start up stage – which need seed money before the
doors can be opened for business
Growth stage in which the business is expanding and
financing becomes possible through several sources
The maturity stage, in which the firm need a
substantial input of capital to support continuing
(and usually fast) growth
Source of funding at start - up
Personal financing -you and your business
partners savings
Friends and family - in form of loans and
investment, outright gifts, reduced rent etc
Bootstrapping – finding ways to avoid the need
for external financing through creative ingenuity,
thriftiness, cost cutting, on any other means
Wealthy investors - in form of equity capital
 Borrowing backed by collaterals like insurance policies
and stocks, homes
Mortgage
Hire purchase
Micro finance institutions
 Business development corporations
 Venture capital firms – firms specializing in
supplying equity capital for business with high growth
potential.
Looks for unique, exciting, fast growing companies in an
expanding field
Why most new ventures need funding
Three reasons why most entrepreneurial venture need
to raise money during early life:
Cash flow challenges
Capital investments
Lengthy product development cycle
Cash flow Capital Lengthy product
challenges investment investment cycle

• Inventory must • The cost of Some products are

be purchased buying real under
• Employees estate, development for
must be trained • building years before they
and paid facilities, and generate earnings.
• advertisements • purchasing The upfront costs
must be paid equipment often exceeds the
for before cash typically firms ability to
is generated exceeds a firms fund these
from sales ability to activities on its
• etc provide funds own
for these needs
on its own
1. Cash flow challenges
Need for cash to serve its customers
Equipment to be purchased
New employees hired and trained
Advertisement
All these before increased customer base translates into
additional income

The lag between spending to generate revenue and earn

income from the firms operations create cash flow
challenges , particularly for new small businesses and
also for ventures that are rapidly growing
Burn rate
If a firm operates in the red, its negative real time cash
flow usually computed monthly is called its burn rate.
A company’s burn rate is the rate at which it is
spending its capital until it reaches its profitability.
Negative cash flow is justified early in a firms life – but
can cause severe complications.
A firm usually fails if it burns through all its capital
before it becomes profitable – this is why inadequate
financial resources is one of the primary reasons for
firms fail
What to do to avoid cash flow challenges
Get credit from banks – not a viable option for many
start up firms because many banks do not lend to new
businesses
Venture capitalist or new investment financiers
Bootstrap your operations
Arrange some type of creative financing
Bootstrapping
Defined as finding ways to avoid the need for external
financing or funding through creativity, ingenuity,
thriftiness, cost cutting or any means necessary - “
pull yourself up by your bootstraps”
Examples of bootstrapping methods
Buy used instead of new equipment
Lease equipment instead of buying
Obtain payment in advance from customers (rent plus
deposit)
Minimize personal expenses
Avoid unnecessary expenses such as expensive office
furniture and space
Buy items cheaply but prudently through discounted
outlets or online auctions
Share office space or employees with other businesses
Coordinate purchases with other businesses
(supermaket purchases from factory)
2. Capital investments
(Financial needs)
For buying properties ,
 constructing building,
 purchasing equipment, or
 investing in other capital projects
When capital is not available for these – lease, or co-
opt resources from alliance partners
However at some point in time the firm will have to
buy equipment / construct to make economic sense of
investment
3. Lengthy product development
cycle
Need to pay upfront for product development
(EXAMPLE Pharmaceuticals) , real estate
developments.
Preparing to raise debt or equity capital
Once start up financial needs exceed personal
finances, friends, family, and bootstrapping then the
next option is to go for debt and equity financing
What to do?
Step 1: determine precisely what the firm needs
Step 1: What does the firm need?
Important because:
The firm does not want to get caught short of cash (not
being able to meet obligations).
and yet the firm does not want to pay for capital it does
not need (borrowing too much and paying interest on
money that was not needed.)
Entrepreneurs talking to potential lenders or investors
make a poor presentation if they appear uncertain about
the amount of money needed
What to do - Construct and analyse a cash flow
statement – should already be in the business plan
Step 2: Determine the most appropriate
sources of funds
Two common alternatives for raising money:
Debt financing
Equity financing

Equity financing
 exchanging partial ownership in a firm for funds
Can be through:
1. venture capital ( money invested by venture capital
firms in start up and small businesses with exceptional
growth potential)
Equity financing - venture capital cont…
Venture firms are limited partnerships of money
managers who raise money/ ‘funds’ to invest in start
ups or growing firms . The funds or the pool of money
is raised up from wealthy individual , pension plans,
foreign investments etc in exchange for equity
2. Initial public offering
3. Business angel investors
 Wealthy individuals who invest their
personal capital directly in start ups)for a
percentage of equity
Also on the look out for companies which

have potential for growth

Debt financing
Involves
getting a loan
Selling corporate bonds

Types of loans:
 single purpose loans - specific amount to be repaid in
a fixed period of time with interest
Line of credit - overdraft facility – can use the credit at
their discretion. Requires periodic interest payments
Most common sources of debt financing
Commercial banks
 Working capital
 Fixed assets
 Account receivable financing
 Credit cards

Government guaranteed programs – youth enterprise

fund, women enterprise fund etc
Micro finance institutions
Business development corporations
Advantages
Equity financing and
Debtdisadvantages
financing
Advantages Advantage:
•Payment is usually based on •No ownership is surrendered
profitability •Interest payment is tax
•No conditions imposed deductible in contrast to
dividend payment paid to
Disadvantages; investors
•Surrender ownership Disadvantage:
•No tax benefit •It must be repaid – difficult
especially because the
entrepreneur is focused on
getting the firm off the ground
•Lender imposes strict
conditions on loans - ample
security,
Other creative ways of funding your
business
Leasing - the owner of a piece of property allows and
individual or business to use the property for a
specified period of time in exchange for payments
Advantage – allows the company the use of asset with
very little or no down payment(EXAMPLE OF
UCHUMI/ NAKUMAT

Hire purchase (eg matatus)

Mortgages (commercial outlets)

Sources

 Suppliers - especially suppliers of inventory by:

 offering attractive terms for payment
 Trade discounts
Sources ( cont..)
3. Micro finance institutions
4. Business development corporations
5. Venture capital firms – firms specializing in
supplying equity capital for business with high growth
potential.
Looks for unique, exciting, fast growing companies in an
expanding field
7. Profits that is put back into the business
Maturity stage - sources
 a stage where the business tends to outgrow its ability
to finance further expansion with cash generated from
its own internal operations and external sources
described earlier
At this point the business will:
 want to move into new markets
 construct new plant or distribution outlets, purchase
more equipment
 need more money for marketing to meet increased
competition
Sources of funds at growth stage
Here your need additional finances to for business
expansion - hire full time personal, building new
facilities, purchase of equipment and machinery, new
product development

By this time the business will have developed its

product or services, successfully marketed what the
business offers and generated acceptable sales
revenue
sources
Public sale of stocks
Merger
Planning for your financial requirements
Planning required:
Two categories: long term and short term
Long term – for capital investment
Short term – to take care of cash deficiencies that
occurs from time to time
Key planning tools
Balance sheet
Forecasted monthly sales
Cash flow analysis
Income statements
Breakeven analysis
Ratio analysis necessary – current ratio, acid test ratio,
net profit to net sales
What determines which source to go for?
Purpose
Amount
Repayment
Terms and conditions
Security
Availability
costs
 Getting started
Meeting all legal requirements
Registration
Identification and recruitment of staff
Creating commitment and buy ins
Opening bank account