Understanding Business Finance

The following article will outline the importance of understanding business finance and the different means of accessing capital through business financing. First of all, business Finance can be defined as ‘involving the raising and managing of funds by organisations’. This involves a high degree of planning, analysis, and control and is usually the responsibility of a financial manager who is higher up in the organisational structure of the firm.

Most businesses will eventually need to access capital through business financing. As a matter of fact, many large-scale companies regularly source capital to meet short-term obligations. For small businesses, it is crucial to source the right funding option as if money is accessed through the wrong source you could lock yourself into unwanted repayment terms or even risk losing a part of your company, both severely damaging your business growth.

It is apparent that financial decisions have the power to impact both profitability and overall risk involved in the operations of a firm. As a whole, business finance can be divided into two major groups; debt finance and equity finance. Debt finance involves borrowing money from a lender and equity finance involves receiving money in exchange for part ownership of a business.

When it comes to debt and equity financing there is a fine line between balancing risk and profitability in order to maintain the value of a firm’s securities in the long run. Continue reading to find out more about the specifics of these two groups and the associated advantages and disadvantages.

Debt vs. Equity Finance

Debt Finance

Debt financing involves borrowing money from a lender, in most cases a loan from the bank. This money is paid back over time including any additional fees or interest. This method has a relatively low barrier to entry, therefore making it a viable option for many start-ups to take advantage of. Other types include business credit cards, finance companies Buy Now Pay Later schemes, overdrafts, supplier credit, or personal loans from friends and family.

Advantages of Debt Finance

  • You hold complete control over your business.
  • You maintain all decision-making.
  • Time limit means that once the debt is repaid, the liability is over and your relationship with the financer ends.
  • The interest you pay on your loan may be tax-deductible.
  • It is easy to forecast expenses as loan repayments are not subject to fluctuation.

On the other hand, what if your company hits a rough patch or the economy takes a downturn? What is the business does not grow as well as you had initially expected? This is where the disadvantages of debt financing arise…

Disadvantages of Debt Finance

  • Debt is an expense and is payable on a regular schedule.
  • These consistent expenses can put a serious hold on company growth.
  • It is easy for debt costs to spiral out of control without a full understanding of fees or adequate risk mitigation in place.
  • Debt financing may involve certain restrictions on company activities, preventing you from taking advantage of outside opportunities i.e. external investment.
  • Businesses in ‘risky industries’ with inconsistent cash flow (e.g. seasonal-based businesses) tend to have a difficult time obtaining debt finance.

Overall, having a low debt-to-equity ratio is usually looked upon favourably, particularly if you are looking to access debt financing consistently throughout the future. Notably, the main difference between debt and equity financing is debt financing allows you to maintain more control over your business. Now, we will discuss equity financing in more detail and the associated benefits and downfalls.

Equity Finance

Equity financing is where a portion of the companies equity is sold in return for capital (i.e. selling shares in your company). There are a range of sources of equity, such as private investors, venture capitalists, friends and family, personal savings, or the stock market. Unlike debt finance where you make repayments on a regular basis, your investors will receive their money in return through business profits.

Advantages of Equity Finance

  • No obligation to repay the money acquired.
  • Less financial risk involved as you don’t have a debt for repayment.
  • More capital to invest in a growing business.

This isn’t to say that there aren’t any downsides to equity finance. In fact, this can carry quite serious consequences if you’re not cautious.

Disadvantages of Equity Finance

  • Giving up partial ownership of the business involves shared profits.
  • Partners in the business must be involved in decisions made that impact the company.
  • The only way to remove investors is by buying them out. As a result, this may be more expensive than what you received from them initially.

At the end of the day, you are putting your company in the hands of other people. And these people also play a part in the outcome of your business decisions. So, think wisely when choosing equity finance to raise capital for your business.

Before making any financial decisions, always ensure to do your due diligence and look into all available options. Besides debt and equity financing, there are an array of other finance options to consider. Such as crowdfunding or a small business grant.

We hope this blog on understanding business finance was informative and helpful.

Looking for financial advice for your business? BUSINESSNAV is here to help you stay on top of your finances, generate cash flow, and ultimately, navigate your business to growth.

Contact us here today or find out more via our website here.