Article provided by Mercantile Bank
Television shows like Shark Tank and Dragon’s Den have brought business pitches and the world of entrepreneurs into the mainstream and made it “sexy”.
Although small business owners on these shows can hook a shark or get a dragon to invest in their business; entrepreneurs should know the different kinds of funding available and which is suitable for established businesses.
The entrepreneurs on shows like Shark Tank typically have an idea, but more often than not without a proven track record of doing business. The Sharks in turn – being venture capitalists – offer money in exchange for equity in the business in the form of a percentage of the shares in the company.
In contrast, banks do not look to “invest” in a business by taking a stake through part ownership, but provide funding in the form of different types of loans. Banks usually look at more established businesses and therefore it is important for the business owner to know what type of funding (assets, working capital, property, etc.) is available and the reason why they need funding.
As opposed to a short pitch and investing in a young start-up, as is the case with the TV shows, the bank will need certain information from the entrepreneur to assess the business and decide if they are willing to take the risk and finance the business.
The information that banks need include the following:
Annual financial statements (AFS): The AFS of a business is the equivalent of an individual’s CV. It provides the banker with an overview of the track record of the business, how it has performed financially and gives a sense of the health of the business.
The AFS includes a balance sheet and an income statement.
The balance sheet gives a snapshot of the assets, liabilities, and equity of the business on the year-end date.
From the balance sheet, certain key ratios can be calculated to assess the business, including solvency and liquidity.
The income statement provides an overview of the income, expenses, and profit for the year. From the income statement, important ratios can be calculated to assess the profitability of the company, including gross profit and net profit margins.
Management accounts: Every business should have management accounts, an important gauge of how your business is performing. These should be reviewed by the business owner on a regular basis, as well as third-party advisors, including your banker.
A business that has accurate and up-to-date management accounts lowers the risk for the bank, because then the business owner is more likely to understand the business and have a finger on the pulse of its activities which lowers the risk (for the business and the bank), and is more likely to succeed.
Cash flow projections: Turnover is vanity, profit is sanity, but cash flow is reality, goes the saying.
Cash flow is the lifeblood of any business and provides a realistic view of the cash generated by the business. Cash flow projections, on the other hand, give insight into future revenue or income that the business will generate; this can either be as a result of gaining new customers or securing more contracts (depending on the nature of the business).
If a business owner is on top of its cash flow, the business is more likely to succeed and funders will also be more willing to lend it money. The lender will be able to clearly see if the business will be able to pay its instalments and interest due on the loan.
These projections will also enable the bank to determine what the need is in the business in terms of funding and therefore make sure that the business gets the right financing for its needs, for example, an overdraft vs. a term loan.
Businesses, be it a company, close corporation, or sole proprietor, should have these available for the banker to inspect – this is non-negotiable.
If a business has up-to-date AFS, management accounts, and cash flow projections, it shows funders, as a start, it has the basics in place, and therefore also that the business is more likely to succeed.