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When it comes to financing, being approved for a loan can potentially take up a lot of time and attention of small business owners, but my experience suggests there’s a more important detail to consider. Prior to investing time and resources in applications, shouldn’t we first ask ourselves “Is this the right type of finance for my business?”
There are many different circumstances small businesses can find themselves in, and a traditional business loan isn’t suited to each. To best illustrate this, I’ll show how three separate scenarios could affect a business in different ways, and therefore could require a variety of approaches to financing.
Scenario 1: Big customer order
Meet Tasty Cakes, an imaginary business that will serve as our example. Tasty Cakes is a bakery which operates on two fronts; it supplies events with pastries, and also has a brick-and-mortar store to sell its products directly to consumers.
Because it’s a fairly young business, most of the bakery’s event-related contracts so far have been small. To be cost-efficient, Tasty Cakes determines how much stock to keep on hand based on this level of demand, and plans its finances accordingly.
At one point, a new customer approaches them with a contract that is considerably larger than their usual workflow—for example, a large-scale event which needs regular rounds of catering. The contract could be a lucrative opportunity for the bakery, but it doesn’t come without some challenges.
The order will demand much more additional stock, along with storage and perhaps even the need for some extra pairs of hands. Most of the revenue won’t come in until after the event, meaning that the bakery has to put down a large portion of its cash flow reserves for several months before it starts seeing any rewards.
On top of that, the business has to continue managing its obligations to other customers, which comes with costs of its own. Tasty Cakes might have to reject the contract if its finances can’t handle the cash flow pressure and there isn’t enough time to arrange a loan.
So how do we avoid this?
Solution: A business line of credit
A credit line can resolve the situation in one of two ways. As a start, it can quickly provide the bakery with the necessary funds, especially if the business approaches an online lender who can make a decision within one working day.
Alternatively, it can be used as a source of emergency funding if it’s been set up at an earlier point in time. In most cases, fees and charges are not applied until you decide to draw down from your credit line, which is why I particularly recommend this approach when building a safety net around your business finances. The bakery might not have needed the extra funding when initially arranging the credit line, but a few months down the road, the available credit will certainly ease the financial pressure of their new contract.
Scenario 2: Delayed customer payments
With or without a large order, the bakery could also find itself in a challenging position if customer payments remain outstanding. It’s a fact painfully clear to small businesses of all kinds—delayed invoices disrupt cash flow and render them unable to purchase supplies for incoming work.
The results are either rejected opportunities or serious financial risks. Chasing up clients for outstanding payments might not be the preferable solution for some, but what other way is there to deal with such a situation?
Solution: Invoice finance
Remember that with outstanding invoices, their monetary value might not be evident in your cash flow, but it’s still a form of cash you can leverage. When applying for invoice finance, you’re selling the value of your accounts receivable in exchange for immediate cash.
Keep in mind that lenders differ in their repayment conditions. Some will directly deal with the bakery’s clients, which might damage relationships and reduce the chance of more business.
There are lenders who offer a confidential service, but their approval process would rely on Tasty Cakes having a large pool of customers where no single one holds a considerable portion of the owed capital.
The risk otherwise is too high for the lender, meaning that the bakery isn’t approved or the fees become hard to stomach. If the business doesn’t meet these criteria and doesn’t want to risk souring relations with customers, a line of credit could still be a viable solution.
Scenario 3: Launching a new service
The previous examples shed light on how to acquire finance in order to maintain a steady cash flow. In the last one, I’d like to explore a scenario where the bakery needs to finance the growth of its business. Let’s say it’s planning to introduce a new subscription service where it delivers a box full of pastries once a week to its customers.
While building this product, the bakery is faced with two challenges—firstly, it needs capital to cover the added costs before it can start seeing a regular revenue stream from the service; on top of that, there aren’t any hard numbers that show just how much interest there might be in the service, making it hard to decide on the amount of supplies needed for the initial rounds of deliveries.
Solution: Subscription sales
If the bakery has accumulated a sizeable number of regular customers, it could consider covering its initial production costs by pre-selling them monthly or quarterly subscriptions at a reduced cost.
This approach can kill two birds with one stone. Firstly, it would bring the capital the bakery needs to kickstart the project without disrupting its usual cash flow. Secondly, it would help the business determine just how much customer interest there is towards the new service, rather than relying only on guesswork. The bakery can purchase adequate levels of supplies rather than overspend and inadvertently damage its financial health.
The essential step the bakery needs to keep in mind is having a robust plan on how to make good on promises to customers. A move like this could present considerably more risk than securing finance from a lender, but for the right business model, it could prove to be the best option.
To sum up, many enterprises will experience similarly rapid and dynamic shifts in their circumstances. A business loan could very well be the best option for your current plans, but it might be ill-suited for other endeavours. When you’re equipped with knowledge of the different alternatives available to you, you’ll be making the most essential investment of all—finding a lending service that’s right for you, and not the other way around.
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