Why do businesses need finance?

Some business owners feel uncomfortable about finance, while others see it as a necessary tool to reaching new heights. So, when and why should a business look to borrow?

By Bonnie Christian on 24/05/2019

Blog Image | Businesses often need finance to grow | Headline 1

Taking the next steps towards business growth often means looking to secure financial backing. But, before we decide where those funds will come from, as business owners the first step should be to have a clear idea about why we need them. Some of the most common reasons involve the day-to-day running of the business, or simply getting it off the ground.

Here, we explore why a growing business might need to seek finance.

Working capital

For most businesses shifting from a small to medium size, their day-to-day expenses – paying employee wages, rent or paying for stock and equipment – will inevitably grow. These outgoings are known as working capital, and are the number one reason a business owner will seek finance.

It is also common to see seasonal businesses seek out short-term loans for working capital in times of low cash flow. Cafes, gift shops and B&Bs in seaside towns might see slow periods in the winter months, for example. Their loan can then be repaid in the summer months, when the business hits its busy season.

Other industries that tend to seek out this type of finance are those where invoices take a long time to pay. Construction, haulage and mining, for example, tend to have a 60-day term on their invoices. During this period two or more staff payroll runs will need to be covered. Seeking finance helps to bridge this gap in funding, in a way that’s quick, easy and can be paid back in a relatively short space of time.

Making sure you’ve applied for the right amount will require analysis of your overheads and income. It's key to understand your own business cycle, as well as how long it takes to convert working capital into cash. Getting advice from an accountant to help crunch the numbers on how much to borrow is the best way to make sure a loan doesn’t fall short or is above what’s required.

Asset purchase

Buying property, machinery, or even software is an inevitable step towards growing a small business. Often, however, it can be hard to find a large sum of money or save up to buy an asset outright, so it tends to be a time when a business owner might seek to take out a loan.

The owner of a delivery business might need to buy a vehicle that costs tens of thousands of pounds, for instance. If it is needed to immediately generate revenue – such as winning a contract that requires expanding the fleet – it can be difficult to find that sum of money at short notice. Seeking a loan to cover the purchase of the extra vehicle would not only help the business meet the contract’s obligations but also help it expand and make it more profitable.

Creating a business plan and forecast of your expected income costs and potential profit can be vital to knowing how much and for what kind of assets to purchase. A business owner borrowing £100,000 at a 10 percent interest rate and knowing they will have to make 11 repayments of 10,000 each, needs to make sure they are generating enough cash to make the payments and still be profitable.

Being aware of the type of loan you may need to seek is another consideration. Lenders rarely finance an asset purchase without taking security over the asset that is being bought - what is known as a secured loan. This is to protect themselves by taking on less risk. The flipside benefit of this for the borrower is that higher figures can be loaned over long periods of repayment.

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Business startup costs

If you’re looking to startup your own business because you’ve had a new idea that you think could be profitable, or you want to turn a hobby into an earner, there can be a few barriers of entry to make that next step.

These include covering your working capital requirements and asset purchases, but also upfront costs such as seeking legal, accounting or business advice; looking to patent or trademark an idea or brand; or putting down a deposit for a lease – all things you might not be able to get your business up and running without.

Options such as saving can take a long time, and entering into a joint venture with a partner can dilute control and your own profits.

So, another option is to seek a small business loan. Getting advice from an accountant first can help with knowing how much to borrow and how to structure a loan – with the lender taking security over physical assets for instance or opting for a shorter term unsecured loan.

If you’re starting up a cafe for instance, it needs to sell coffee, a hard thing to do without buying an expensive coffee machine. A purchase like this can a take long time to save up for and if you want to start a business now or an opportunity has presented itself now, seeking finance to buy the machine is a good option. It also allows you to spread the cost of the machine over a longer period of time while the cafe generates revenue, enabling the repayment of the loan.