Internal sources of funding have the advantage of being less expensive and taking less time to secure. The disadvantages of using internal sources of funding may include not having a close relationship with an outside lending source when one is needed, not accumulating a credit history, and inconsistency in the available cash because of fluctuations in the company's cash flow situation.
Personal Savings and Home Equity Loans
Using personal savings or borrowing money from the equity you have built in your home are by far the most inexpensive ways to obtain funding for your business. By using your own funds you will also maintain total control of your business. You will want to take into consideration a few issues, however, before pulling these funds into your business. First, how will using your savings or home equity impact your personal financial security? What impact could losing this money have on your future? You will also want to consider that as you develop a relationship with a bank or lending company and repay the loan, your business is creating a much-needed credit record.
Friends and Family
Money borrowed from relatives and friends is another relatively easy source of funding. Although this source of funding may be external to the business and its owners, it is considered an internal source because it is obtained solely through close, personal relationships. Generally these sources will not require completed applications or certain credit scores. The strings attached to these loans or equity investments, however, may be rather tangled. Before receiving these funds, be sure to fully understand all requirements and expectations of the funders. Take into consideration the potential fallout (loss of friendships or uneasy family relations) if something goes wrong and you can't pay the loan back on time or the business doesn't make it. You should establish a clear understanding of the risk associated with the investment, as well as repayment expectations for loans that include interest rates, term life insurance to pay your debt in case something happens to you, and contingencies for not being able to repay the loan.
Many entrepreneurs use credit cards as a means to provide cash to a business. One reason is that they can get money quickly with little, if any, application process. You should only use credit card debt for a specific purpose with a plan to approach more traditional, less expensive funding options in the future.
As with any other debt, credit card debt must be repaid. This payment process can often be difficult given the combination of a business's tight cash flow and the credit card company's excessive interest rates. Because credit card debt is unsecured, it is a personal debt. Using credit cards can risk your personal assets.
Here are some tips to using credit card debt safely:
- Treat the debt as a regular loan with a set payback period and affordable monthly payments. In other words, never borrow more than you can pay back.
- Look for low, fixed interest rates. Moving your balance from card to card, for a time, can help you keep these low rates.
- Take advantage of the incentives of the credit card such as cash-back bonuses for purchases you might normally write a check for. To avoid taking on too much debt, never charge more than you have established in your monthly budget.
- Make sure that any cash-advance checks are made out to your company and make a copy for your records. This way you'll have proof that the cash advances were used to expand your company and not used for personal expenditures.
Current Earnings (Profits)
Businesses are expected to generate cash flow from current earnings. At the completion of the cash cycle, your business should have cash left over after all expenses have been paid. This internal cash flow is an integral part of every business because unless a business is profitable, it is paying out more in expenses than it is receiving in sales. Profitable businesses generate enough cash to pay back loans, finance growth, or pay dividends to the owners.
FastTrac Kauffman Foundation