We all know the phrase “Cash is King”, which can lead us to believe that cash is best. When I was young, I was so nervous to get lost in credit card debt that I paid cash for everything just to be safe. Little did I know that I was missing out on some sweet reward earnings and, more importantly, missing out on the opportunity to build up my credit. When it comes to financing business transactions, the stakes and opportunities are even higher. There are many more options and considerations to be made. So, when you have purchases to make for your startup, how should you finance it?
Let’s start with the most obvious – cash. Cash and expense can often be confused or thought of as one and the same, but that’s not the case with accrual accounting. A business with positive net income may very well be short on cash, or vice versa. With that, it’s important to plan cash expenditures carefully and make sure each dollar is best used. If you’re like my young self, you may think it’s better to play it safe and pay cash but that could carry a high opportunity cost by using up a limited resource too quickly. When interest rates are low, or cash is short, borrowing may be a good option.
2. Corporate Credit Card
One of the easiest payment options is a corporate credit card, but entrepreneur-be-warned this tool is best used when it’s treated like 30-day cash. One of the greatest benefits of corporate credit cards to a business is simply the convenience. The rewards can be pretty enticing too, as they can often be used to offset costs that help you run your business (airfare!). That being said, it typically comes with higher interest rates and fees. If you carry the balance for multiple billing cycles, you will continue to incur interest expense and ultimately outweigh those benefits with a higher net cost.
3. Line of Credit
A bank line of credit can be a great finance tool for a business. A line of credit, or LOC, can be a great resource for short term financing needs and serve as a safety net to businesses. It is especially helpful for businesses that have some seasonality in demand or lumpy cash transactions as it’s best used to cover a short-term gap in the availability of cash. Interest is typically accrued daily on a bank LOC, so it is important to do some research on rates before entering the agreement as a small rate decrease can make a big difference over time. It’s also best to talk to your banker early and secure a LOC when the business doesn’t need it since it can be difficult to get bank approval in a pinch.
4. Leverage Assets to Borrow Cash
If the business has assets, (think equipment, buildings, vehicles, even accounts receivable) it can leverage the value of those assets as collateral to borrow cash from the bank. This option may offer the most favorable interest rates and longer-term repayment periods which makes it a great tool for strategic investment. On the contrary, it does require that the business have assets to serve as collateral, so it may limit the borrowing power of a startup business. In any event, you’ll want to start a good relationship with a reliable banker so you can take advantage of this borrowing option when it’s right for the business.
5. Don’t Make Direct Purchases
Another way to finance investments in the business is not to make direct purchases at all; instead look to lease agreements. Leases can be a great way for businesses to purchase equipment and other tangible assets because they are often easy to obtain, require less cash upfront, give the business access to regular equipment upgrades, and pass along the risk and burden of obsolescence to the lessor. On the contrary, leases can come with steep financing fees and interest so the cost over time will likely exceed that of an outright purchase. Terms and conditions can be relatively inflexible for the duration of the lease term, so be thoughtful when setting the duration of the lease contract.
When financing your business operations and capital investments it’s important to consider what opportunities and challenges are unique to your business. Interest rates, tax impact, budget, and strategic goals should be reviewed just to name a few! There is no “one size fits all” but with a quick cost/benefit review of the options available, your business can maximize the efficiency of its assets and cash flow for optimal impact. Let us know on Twitter of any instances where you chose one option over another and why!
Janelle Gorman is the Chief Financial Officer at TRM Microwave. Reach her on Twitter: @JCGorman