Capital is the money available to your business for operations. As your business grows, so does your need for capital. There is more than one way and more than one place to find the money you need. Choosing the right form of additional money for your business is related to why the business needs capital.
There are many factors that can create a need for additional capital. Some of the more common are:
- Sales growth requires inventories to be built to support the higher sales level.
- Sales growth creates a larger volume of accounts receivable.
- Growth requires the business to carry larger cash balances in order to meet its current obligations to employees, trade creditors, and others.
- Expansion opportunities such as a decision to open a new branch, add a new product, or increase capacity.
- Cost savings opportunities such as equipment purchases that will lower production costs or reduce operating expenses.
- Opportunities to realize substantial savings by taking advantage of quantity discounts on purchases that will lower production costs or reduce operating expenses.
- Opportunities to realize substantial savings by taking advantage of quantity discounts on purchases for inventory, or building inventories prior to a supplier's price increase.
- Seasonal factors, where inventories must be built before the selling season begins and receivables may not be collected until 30 to 60 days after the selling season ends.
- Current repayment of obligations or debts may require more cash than is immediately available.
- Local or national economic conditions which cause sales and profit to decline temporarily.
- Economic difficulties of customers that can cause them to pay more slowly than expected.
- Failure to retain sufficient earnings in the business.
- Inattention to asset management may have allowed inventories or accounts receivable to get out of hand.
Frequently, the cause cannot be entirely attributed to any one of these factors, but results from a combination of them. For example, a growing, apparently successful business may find that it does not have sufficient cash on hand to meet a current debt installment or to expand to a new location because customers have been slow in paying.
Capital needs can be classified as either short- or long-term. Short-term needs are generally those of less than one year. Long-term needs are those of more than one year.
Short-term financing is most common for assets that turn over quickly such as accounts receivable or inventories. Seasonal businesses that must build inventories in anticipation of selling requirements and will not collect receivables until after the selling season often need short-term financing for the interim. Contractors with substantial work-in-process inventories often need short-term financing until payment is received. Wholesalers and manufacturers with a major portion of their assets tied up in inventories and/or receivables also require short-term financing in anticipation of payments from customers.
Long-term financing is more often associated with the need for fixed assets such as property, manufacturing plants, and equipment where the assets will be used in the business for several years. It is also a practical alternative in many situations where short-term financing requirements recur on a regular basis.
A series of recurring, short-term needs could often be more realistically viewed as a long-term need. The addition of long-term capital should eliminate the short-term problems and the crises that could occur if capital were not available to meet a short-term need.
Whenever the need for additional capital grows continually without any significant pattern, as in the case of a company with steady sales and profit from year to year, long-term financing is probably more appropriate.
Here are some Available Sources of Capital to help you find the right financing for your business.