Determining Your Capital Needs In Business – Why Is It Important?
Many entrepreneurs are unaware of the importance that capital is to their business. Capital helps nourish the growth of entrepreneurs’ business ideas into reality, which will be critical to their success. There are many ways to obtain capital from private funding to traditional banks and even from funding options in a business venture loan.
However, since obtaining a business venture loan can take a very long time, there is value in financing your business necessities effectively and timely with a personal loan for entrepreneurs with good credit scores. Keep reading to know more about determining your capital needs in business and why it is important for your further success.
How To Determine Your Capital Needs In Business?
To get the capital that you require, you must know your capital needs in your business. Generally speaking, your needs will be determined by the type of business you are starting, along with additional factors like seasonality, number of employees, monthly expenses, etc. When you have determined the type of business you are starting, along with these additional factors, there are two ways to determine your capital needs in business.
Using A Capital Budgeting Model
A capital budgeting model is an easy way to figure out your capital needs in business. However, it will be critical for you to have good cash flow forecasting skills since the main purpose of using a capital budgeting model is to determine the optimal timing for purchasing fixed assets. This method involves calculating various scenarios to find an optimal plan for future cash flows based on the factors that will affect them.
Using The Unit-Of-Production Method
The second method is the unit-of-production method. In this case, you will need to figure out the capital needs of your business at a future date, and then you can use that to determine the required amount of capital for that date. You can find the answers to these questions by determining:
- Your sales – What is your revenue? How many sales will you make? This will tell you how much profit is expected from operations and how much working capital is needed. It also lets you know what level of sales must be attained to break even (or if profit is expected).
- Your expenses – What are your total costs? This will also tell you the amount of working capital needed to operate your business. This amount will vary based on the factors you have determined earlier.
It is essential to understand that the stages in case 2 are based on future projections, which means that you must estimate what factors will impact current cash flows to project future cash flows. The idea is for you to find a method that fits your business’s needs. Be sure to check with a financial advisor or accountant if necessary.
Questions That Will Help You Determine Your Capital Needs In Business
Once you determine the level of sales and expenses for your business, you will determine the capital needs in business. Here are some questions that will help you determine your capital needs:
- Type Of Business – To start a new business, you need to consider the type of business. If it is an online retail store, you must consider how much it costs to hire and retain employees and whether or not there is seasonal demand (i.e., Christmas).
- Seasonality – Several factors can affect seasonality, including local economic conditions, holidays, weather, and price competition. For example, it is difficult to lose money in the holiday season, but in the summer months, when they are selling less expensive items, there can be a lot of competition, and margins will be tight.
- Number Of Employees – You must consider your number of employees and how much they will cost in payroll and benefits. There are different considerations when it comes to hiring employees for seasonal positions versus full-time positions. If you have seasonal positions, you must be ready for lower employee turnover rates. In contrast, if you hire full-time employees, expect higher costs.
- Monthly Expenses – In addition to payroll, you will have other expenses that can vary from month to month, such as rent, utilities, and insurance premiums. Having a fixed or low rent is an advantage over having high rent because you must pay the rent, even if sales are down.
- Vendor Credit Availability – If you have unique items that are difficult to find elsewhere, you may be able to negotiate for better payment terms with vendors. Having timely payment terms with vendors is critical to maintaining vendor credit availability.
Common Sources Of Short-Term Business Capital Financing
There are many short-term business capital financing sources, including trade creditors, payday loans, factoring, and line of credit.
Credit from trade creditors is often seen as a good source of short-term business capital financing because it is easiest. Trade creditors are basically businesses that you have done business with in the past. These creditors will extend credit on a verbal agreement on the assumption that you have a recurring business. However, there are cases where payment is slow or not made at all because trade creditors choose to wait until the end of their fiscal period. There are also instances where they sell their accounts receivables (if allowed) to collect payments before you pay them.
Payday loans are short-term advances of money that are made available within a period of two to ten days. Payday loans are regulated by the state in which they are issued, but they do not require checking or bank approval. Usually, loans are deposited on prepaid debit cards if needed.
You have to leave collateral in the form of your checking account, car title, or some other item that you can quickly liquidate to obtain access to your money until your payment is received. If you have bad credit, the interest rates are typically higher than for other types of short-term instalment loans.
Factoring is another source of short-term business capital financing. You can request your business to be factored in if you have sales below the minimum credit line. Factoring is also called invoice discounting or invoice finance.
A merchant account provider will take your invoices and apply a discount to purchase their services until your customer pays them in full. This kind of financing is typically short-term because the interest rates are generally higher than for traditional bank loans or personal loans.
Line Of Credit
A line of credit is typically used by businesses that need to make large purchases in a short period, such as machinery, plants, and equipment, computer equipment, etc. Your bank will set up an account for you with a line of credit that is limited to a certain amount. This will depend on how your business has been doing, but most banks will expect to see monthly sales of several thousand dollars for you before they extend a line of credit.
The Bottom Line
Business capital is very important. It is the money you will use to buy items or supplies, pay employees and make ordinary expenses. For refinancing business capital, you should understand the amount of capital required for an individual business. This will be determined by your revenue, expenses, assets, and liabilities. You must then determine the profit that you expect to make in your business. You can then consider these factors before estimating whether or not to seek financing from a bank or other short-term business capital financing sources to finance your business needs.