“Money is a terrible master but an excellent servant.”
–PT Barnum
What Is Business Financing?
Financing is the process of providing funds for business activities, making purchases, or investing. Financial institutions, such as banks, are in the business of providing capital to businesses, consumers, and investors to help them achieve their goals. The use of financing is vital in any economic system, as it allows companies to purchase products out of their immediate reach.
Many people have a vague goal of achieving financial freedom but don’t clearly define it or set proper goals.
In fact, there are 3 levels of financial status that follow from each other to make the financial continuum. These are as follows:
Level 1 Financial Security:
This means your basic expenses, such as mortgage bills and regular living expenses, are covered by your primary income source, which is typically your job or salary/dividends from your business.
This status is where most people are situated in life.
Level 2 Financial Freedom:
This means you no longer rely on your primary source of income. You have multiple income sources, and these will typically be low-effort or completely passive income sources. This means that you still need to take action in maintaining your sources of income; however, you have much more flexibility in how you spend your time.
People in this bracket are typically making their money work for them.
Level 3 Financial Independence:
This means you are no longer making life decisions based on money and instead do what makes you happy. You would have amassed more money or have very reliable passive income streams that generate so much regular income that you have more money than you can ever want to spend.
To explore how this relates to you, you can ask yourself the following questions:
- What is your current financial status (Level 1,2, or 3 or not at Level 1 yet)?
- How much money do I actually need to attain each status? For example, to achieve level 1, what is your monthly outgoings’ value to cover your basic expenses (food, accommodation, bills, etc.)?
- When would I like to achieve each status? You can use this in your goal-setting exercise later in this module.
Rather than vague money-orientated goals, you should set high-quality goals that are specific. A good example of a money-orientated goal could be: “Achieve Financial Freedom (level 2) status by attaining a passive income of £30k a year in the next five years”.
3 Top Reasons for Business Failure
- Financing Hurdles
A primary reason why small businesses fail is a lack of funding or working capital. In most instances a business owner is intimately aware of how much money is needed to keep operations running on a day-to-day basis, including funding payroll; paying fixed and varied overhead expenses, such as rent and utilities; and ensuring that outside vendors are paid on time. However, owners of failing companies are less in tune with how much revenue is generated by sales of products or services. This disconnect leads to funding shortfalls that can quickly put a small business out of operation.
- Inadequate Management
Another common reason small businesses fail is a lack of business acumen on the part of the management team or business owner. In some instances, a business owner is the only senior-level person within a company, especially when a business is in its first year or two of operation.
- Ineffective Business Planning
Small businesses often overlook the importance of effective business planning prior to opening their doors. A sound business plan should include, at a minimum:
- A clear description of the business
- Current and future employee and management needs
- Opportunities and threats within the broader market
- Capital needs, including projected cash flow and various budgets
- Marketing initiatives
- Competitor analysis
Business owners who fail to address the needs of the business through a well-laid-out plan before operations begin are setting up their companies for serious challenges. Similarly, a business that does not regularly review an initial business plan—or one that is not prepared to adapt to changes in the market or industry—meets potentially insurmountable obstacles throughout the course of its lifetime.
The Importance Of Cashflow Vs Profit
Cash Flow is the money that’s flowing in and out of your small business – hence the name. Having a positive cash flow means that more money is coming into the business than going out. It’s just as important as profit when it comes to determining your business’ performance.
To make things as simple as possible, here are a few quick explanations. If you’re confident you already know your profit from your petty cash, then head to the next section, where we’ll cover precisely why it’s so important to keep an eye on your cash flow.
If your business runs out of cash, and cannot borrow from somebody, then it is probably about to fail.
Keep in mind you might have a high overall profit, but if cash flow is low, then you may still face problems like overspending or ordering too much stock. Fast-growing businesses tend to require more cash to buy stock, hire employees, etc., so it’s vital to keep an eye on cash and cash flow.
Profit is the amount of money left once total costs have been deducted from revenue. Obviously, the higher the number, the better. If the costs outweigh the overall revenue, then a business has operated at a loss and is in financial trouble.
Both elements are essential to the health of a business, but it’s important to know that they’re different. Just because profit is looking healthy, it doesn’t mean you have a positive cash flow to support growth.