Let’s say the loan amount is P2 million, requiring a monthly amortization of P187,000. If the new store produces a monthly average income of only P90,000, you would have a monthly cash shortfall of P97,000. Such a recurring cash shortage could technically force you to close shop even if your business is profitable.
Indeed, many entrepreneurs, by mismatching the risky use of short-term financing with long-term assets, have fallen into this trap.
Another form of external financing is raising funds from investors by issuing equity ownership in the form of common shares in your company. The advantage of equity financing over debt is that the capital provided is interest-free and there’s no requirement for you to pay back.
Since your investors also become part-owners of your business, however, they can influence how you manage the business and have some control over it. For every major business decision that you make, you may need approval from your investors, who may not be as knowledgeable as you are about your industry.
This is sometimes good because it would force you to validate your ideas with outsiders, but if they disapprove of your ideas, they could also limit your creativity. Also, because your investors will demand a decent return on their investment, you would be constantly under pressure to hit your profit targets, and if you fail, you would need to give them an acceptable explanation.
You may want to consider internal financing if external financing is hard to come by, especially during this time when many banks and investors are struggling with financial insecurity.
You can increase the internal cash flows generated by your business by increasing your profit, selling assets, and managing your working capital better. You can increase profits by looking at ways to cut your costs and improve gross margins.
You can also get internal financing by converting slow-moving inventory into cash and reducing your accounts receivable balance.
Another way to get internal funding is to sell the idle assets of your business. These are your assets that have already been fully depreciated and are no longer being used in your operations, such as old equipment, vehicles, or building property.
You can also raise the cash you need by selling some of your company’s assets such as land, or by leasing them with the option to buy them back in the future.
At whatever stage of growth you are in as an entrepreneur, it is very important to explore all possible sources of capital. You need to choose the right mix of debt and equity financing at the least cost that can provide you the most control in managing your business.