Section 1: Starting a Small Business

Financial Considerations

To own and operate a business, you need to have money, pure and simple. Basically, there are two ways entrepreneurs can go about obtaining financing. Whichever way is chosen, there is a cost associated with obtaining money.

Non-Debt Financing

When owners invest their own capital into a business, or have members of their family or friends contribute money, it is considered non-debt financing. This type of financing is also referred to as equity financing in that the money is a form of a business investment. Other business people and institutions such as banks, financial companies, and venture capital investors may also invest in a potentially profitable enterprise. Depending on the form of business ownership, this can mean becoming a partner or receiving shares in a corporation. Equity financing has the distinct advantage of increasing a business's available capital without increasing its debt load.

Debt Financing

Debt financing refers to borrowing money in the form of a loan to finance the operation of a business. When you borrow money, you need to repay the amount of money borrowed, plus a certain amount of interest over a specified period of time or term. The creditor provides the financing to the person in need of the money-the debtor. Two common types of loans available to businesses are an operating loan and a term loan. Each serves a different function.

Operating Loan

An operating loan used to finance day-to-day operations may be extremely instrumental for businesses that sometimes experience cash flow problems. For instance, a restaurant is usually busier on the weekends than during the week. This fluctuation in cash flow makes it difficult to pay for regularly scheduled expenses such as employee salaries and overhead costs such as gas and electric bills.

Small businesses have four different types of operating loans available to meet the operational needs of their enterprise.

Revolving line of credit - a predetermined amount of money available to a business that allows it to withdraw funds as needed.
Non-revolving line of credit - an amount of money made available for a specific purpose. (Allows a business to take advantage of special offers as they arise and there is not enough capital on hand to otherwise take advantage of such opportunities.)
Inventory loan - money that is available to the business owner to purchase inventory for their business. (Being able to purchase in large quantities allows owners to take advantage of lower prices.)
Accounts receivable loan - often businesses need to provide customers with credit. (These types of loans provide money based on the value of company's accounts receivable-the amount of money that the business is owed by customers.

Term Loan

A term loan is used for specific purchases required by a business. It may be needed to purchase new equipment, land, or some other major expense. As with a car loan, the lender is quite likely to secure the loan by claiming an interest in the item being purchased. If the item has no value to a creditor, a guarantee over some other assets may be required. This provides the lender with a degree of certainty that the loan will be repaid. A term loan is for a specified amount of time and the borrower is required to make regularly scheduled payments.

The Advantages of Loans

As with equity financing, there are business advantages to obtaining a loan to finance an enterprise. The most obvious is that no equity is lost. This means that the business is able to benefit from its success without having to share it with other investors. Another advantage is that the business can repay the loan earlier thereby saving interest costs.

Section 1: Summary

As we have learned, establishing a business requires a great deal of planning. There are many factors that need to be taken into consideration, and many decisions that need to be made. As we will discover in the following sections, there are many more decisions to be made when a business actually begins operating.

PLEASE NOTE THAT ALL OF THE SELF-ASSESSMENTS IN THE COURSE ARE FOR REVIEW PURPOSES ONLY; THEY ARE NOT FOR GRADES.