As a small business owner, when you need additional funds for your business you will surely face this dilemma: should you make use of an external source of financing and incur a debt, or leverage the savings that have cost you so much effort to earn? In this article we will analyze in depth that question so that you arrive at the right decision.
But before we begin, we must understand what both concepts mean:
- Savings: This is the assets or money contributed by the owner or owners of the company. There are no interests on your assets. However, everyone who owns capital in a business is entitled to a portion of their earnings. For most small businesses, equity comes from the entrepreneur’s own resources.
- Debt: Many entrepreneurs borrow money from a bank or financial institution to finance their business, buy equipment or pay operating expenses. If you incur a debt, you will be required to pay it along with accrued interest.
How to use your savings to invest in your business
Many entrepreneurs start their businesses using their own funds. The question of whether they should apply for a payday loan and incur a debt simply has no place because they can use the money they have accumulated over the years. Even if they resort to an external source, their own contribution is usually substantial.
In the same way, the lack of initial capital is the main reason why it is very difficult for many entrepreneurs to start their own businesses. However, it is possible to overcome this obstacle by knowing the concept of bootstrapping.
What exactly is bootstrapping and how can it help you when creating your business?
The bootstrapping concept refers to the technique of starting and managing a business with very little capital. The business owner uses his personal finances until the company begins to generate income and profits. If you opt for this method, it could mean not having a salary at the initial stage of your business.
In short, is it a good idea to self-finance your business with your own savings? Here you have the advantages and disadvantages of this method of financing.
Advantages and disadvantages of self-financing your business with your savings
- You do not need to pay interest or worry about paying the amount you have borrowed. This is the great advantage of self-financing your company. The income that your company generates is only for you. You can invest these revenues in your company again.
You can focus on running your business. Keep in mind that getting your loan application approved is not an easy task. You have to meet certain requirements, prepare several documents, send them to the bank, and then wait for an answer. Depending on the institution, the entire process may take weeks or even months, and you may have to make several visits to the bank. If you finance your business, you don’t waste time on these activities. Thus, you can focus exclusively on the activities of your company.
- There is no need to present guarantee or guarantee . If you request a loan from a financial institution, you are likely to be asked to provide some type of guarantee. What is the guarantee or guarantee? Normally it is about your company’s assets, such as your premises or your equipment, but it can also extend to your personal properties. If you cannot return the loan to your lender, they could seize the guarantee you provided. The lender can sell them to pay off the loan. If you use your savings to finance your business, you do not run the risk of losing your assets and properties.
- You can maintain your independence . When you get a loan from a bank or a financial institution, your main concern is to recover the amount that has been lent to you along with the interest you have accumulated. It is true that you can manage your business as you wish, as long as you make your payments on time. But if you are late with payments, you can be sure that your lender will soon take action on the matter. You may have to pay a delay penalty in addition to a higher interest rate. The lender may even require you to pay the full loan amount immediately! However, if you self-finance your business, you will not face any of these problems.
- Not having enough funds is the biggest drawback of self-financing. This is the reason why most small business owners must resort to external sources of financing. You need a considerable amount of money if you want to expand your business, enter a new market or stock up on inventory.
- You do not have the opportunity to build your personal or commercial credit . If you never ask for a loan, how will you build your credit score? Having a solid credit score carries many advantages , while the opposite can prevent your business from expanding in the long term. Most companies need to go to a lender at some point, and if you don’t have a good credit history, getting your loan approved could be more complicated.
- You lose tax benefits. Did you know that the interest you pay for a commercial loan is tax deductible? If you restrict yourself to self-financing, you will not have that benefit.
- You risk “betting everything on a single number”. This is one of the biggest disadvantages of self-financing. Many entrepreneurs invest all their assets in their businesses, and invest all their profits back in their company. If there is an economic recession or if the business suffers losses for some other reason, they can lose everything they have.
How much of my savings should I invest in my business?
You are already familiar with the advantages and disadvantages of self-financing your business, but the next step can be confusing. If you use your own savings, how much should you take to finance your business?
Here you have a possible solution. It’s called the 50/30/20 rule. This is a budget technique that you can use to your advantage.
It consists of three simple steps:
Step 1: Assign 50% of your income to your basic needs. What you pay for rent, your mortgage, supermarket purchases, electricity and water services, etc., fall into this category.
Step 2: Assign another 30% of your income to discretionary expenses. In other words, to leisure activities and what you enjoy. Things like eating out, entertainment expenses and vacations should occupy a maximum of 30% of your monthly budget.
Step 3: Now you have 20% of your income left. You can choose to save it or invest it in your business.
If you follow the principles established in the 50/30/20 rule, you will know exactly how much to invest in your business. However, for most small business owners, the amount they can invest in their businesses is somewhat limited if they follow this rule, since they need most of their money to meet their daily needs.
Tips to self-finance your business
When you have just opened a business, it is very normal for you to use your own funds to get it off the ground. Remember that most lenders are often reluctant to lend money to companies that are less than two years old. Thus, the dilemma of whether to use the savings or to request a loan will surely not arise at all, since any owner of a new company will have difficulties in obtaining a loan.
Therefore, the only viable option if you are starting a business is to use your own funds. To do it correctly, follow these tips:
- Do not use all your savings for your business. You must save some money in an emergency fund. You never know when you may need cash for a medical emergency or an unexpected and substantial purchase.
- Consider carefully how to use the money allocated for your business. You must control your expenses. Do you really need a latest model computer for your work? Or can one that cost you half be as useful?
- Open a high-performance savings account and deposit money regularly. It will help you to help you accumulate funds that you can use in case of emergency.
How to use a loan to invest in your business
Remember that if you borrow money to invest in your company, you must pay it back along with the interest accrued. It is crucial that you understand this responsibility before committing to a loan.
What types of loans are available to small business owners? Here is a simplified list:
- Microcredits: Microcredits usually have amounts less than $ 50,000. In most cases, microcredits have a higher interest rate than loans for a larger amount.
- Small business loans: This type of loan is often the best option for an entrepreneur. Generally, a commercial loan has a reasonable interest rate and is paid in installments ranging from two to five years.
- SBA Loans: The United States Small Business Administration (SBA) is a government agency that provides support to entrepreneurs in this country. SBA loans are among the cheapest in the market, but getting one is usually complicated
- Commercial credit cards: this is a flexible source of financing. Commercial credit cards are also popular because many of them provide additional benefits such as extras in the hotel rooms you book and discounts when you rent a car.
- Equipment financing: if you need to buy new machinery for your business, equipment financing could be a good option. Many manufacturers offer equipment financing for the machinery they sell.
- Credit lines: opting for a credit line is a good idea if you are not sure when you will need funds for your business. The main advantage of this type of financing is that you are charged interest only on the amount you get to use. Therefore, you can get approval on a line of credit and expect to use it only when you need the funds.
- Cash advances from merchants: the biggest advantage of this type of financing is that you don’t need a high credit score. By means of a cash advance the lender or merchant that is provided with the funds gives you a cash advance in exchange for your future sales made with credit cards.
- Alternative sources of capital: If you have just opened your business and have difficulty obtaining loan approval, consider other financing alternatives . You can also consider borrowing from family or friends , or even take out a home equity loan.
Advantages and disadvantages of financing your business with borrowed money
Growing your business with borrowed funds can be a good idea. But borrowing more than due can be a serious problem. Here you have the advantages and disadvantages of this form of financing.
- It allows you to build your credit: by making your loan payments on time, you can build your credit score .
- It allows you to establish a relationship with your lender: you can request a small amount of money even if you do not urgently need the funds. This will help you build a relationship with your lender , an association that could be very useful when your business needs the funds.
- It can help you expand your business quickly: the funds provided provide you with the extra money needed to make your plans and ideas come true .
- You can increase your earnings: imagine a situation in which a business owner borrows money to buy new equipment. The money earned from the sale of products made with the new machinery could be used to pay off the loan. Without the borrowed funds, it would not have been possible to obtain this additional benefit.
- Interests: This is the biggest drawback of borrowing money. Of course, you should expect to have to pay a fair interest rate . But a loan with an unreasonably high cost can affect your earnings.
- Obligation to present guarantees: some lenders will require the borrower to present some type of property or asset to guarantee the loan. This can be a decisive factor for the owner of a small business that cannot provide guarantees.
- Delay: Many lenders take weeks or even months to provide approval. SBA loans may take even longer.
- Time, effort and other expenses: to properly prepare a loan application you must collect your financial statements and other relevant information from the last two years or more. You may need professional help to tidy up your documents and help you with paperwork.
How much should I borrow to invest in my business?
If you finally choose to borrow funds to invest in your business, the next issue to address is deciding how much to borrow .
The first step you should take is to find out how much to invest in your business . To find the answer we advise you to go step by step:
- Define the objectives of your business.
- Decide the amount of investment that will be needed to reach each goal.
Remember that you should not borrow more than necessary. A debt that is too large can only lead to problems. The golden rule to decide the maximum limit of a loan dictates that the monthly payment of your loan should not exceed 80% of your net earnings. This will provide you with a safety net in case you suffer an emergency or if your cash flow decreases for some reason.
You can use a commercial loan calculator to make these calculations correctly.
Tips for borrowing money to finance your business
If you decide to go ahead and borrow money, there are some precautions that you should take:
- Don’t borrow more than you need: you could borrow too much.
- Make sure your company can generate enough cash to pay off the loan it takes.
- Use the funds loaned exclusively for your business. Do not invest in assets that are not productive.
- Select your lender carefully. A wrong choice can lead to high interest costs and lower profitability.
Borrow the right way: choose Ferdies Financial
If you are going to borrow funds for your business, do it with Ferdies Financial. You can start by requesting a quote . This process will take only a few minutes and will not affect your credit score.
A loan from Ferdies Financial combines the advantages that self-financing and external financing can offer you, as well as the free and non-binding advice of a commercial loan specialist. These are some of the other advantages of a Ferdies Financial loan:
- Paying your fees on time will help you build your business credit.
- You can use your loan funds for any purpose related to your business.
- Loan amounts vary from $ 5,000 to $ 400,000, to fit any of your company’s needs.
- You do not need to provide any guarantee.
- Simple, direct, and completely online process, which will save you paperwork and bank visits
- The application process is quick: you can receive your funds in a period of 4 to 10 days.
- You will have to make payments in fixed monthly installments. This guarantees you complete control over your finances and saves you surprises.
Take the first step by completing this loan application . You will instantly know if you have been preapproved and soon after a loan specialist will contact you to guide you through the rest of the process.