Growing a business sucks in cash, that’s the first law of business gravity created by business author Verne Harnish. And it is that cash is the most important thing to keep a business in operation because you could fail in your operations, systems, equipment, marketing but, without cash, everything is simply over.
At the beginning of the year, companies need even more to have a healthy cash flow, however, in the current context it will be even more relevant because we are still carrying the effects of the pandemic, we are facing the highest inflation in the last 20 years (INEGI), there has been a global shortage of products and raw materials, which affects the possibilities of cash growth for Mexican companies.
That is why many entrepreneurs will evaluate the possibility of resorting to financing in the coming months to inject it into their businesses, but before doing so, leaders must be sure if their company is ready for this type of capital. As an advisor, I am scared by the number of entrepreneurs who do not understand their numbers and still seek financing and expect good results.
Understanding your numbers means knowing them in detail: why did a certain amount move? What changed in the last 24 hours? How long does it take for each penny invested to return to your pocket? Only when we understand our numbers can we improve them.
It also means having control over your cash flow, as explained by finance expert Alan Miltz, “Cash flow is the movement of money in all your bank accounts in a given period of time, that is, everything that is transferred inside and outside your accounts ”.
Entrepreneurs often talk about profits and income, but not a word about net cash is why, when they turn to financing, what lenders analyze is not income or profits, but the ability to pay debts. What you may not realize is that earnings and income only make up the first part of your financial history, your complete history is made up of 4 parts:
- Profitability: the critical components for a profitable business
- Working capital: accounts payable, accounts receivable, inventories, etc.
- Other capital: additional assets you have.
- Financing: did you generate enough capital or do you need financing? How to know if your company is ready?
As you can see, financing is the last part, not the first; Business leaders are used to and have been educated to reverse the order to seek financing without ever having their business model checked or without having full knowledge of their finances. Once you have it clear, look for the most convenient to inject to your growth:
1. Debt financing: it consists of borrowing money from a lender that will eventually cover more interest. In other words, it is a loan of a capital that you do not have yet, it is a system that allows you to spend money even before generating it.
The advantages of this type of loan is that you have control of how that capital is spent, it is up to you how you distribute it and invest in the growth of your business and there are many types of loans with wide ranges in terms of the amount and time of payment. .
The risks are in not knowing how to manage it and get returns, according to the SME Credit Report of Fintech Konfío, 92% of SMEs use private financing to cover debts, instead of investing it in current expenses and growth. Another disadvantage is that it can take time to receive the loan based on the credit score and finances of the company.
2. Capital financing: it is when you exchange part of the ownership of your business with investors in exchange for their capital. This is one of the financing most requested by entrepreneurs, the amount of venture capital funds in Mexico reached 152 in September 2020, about 26 funds more than what was registered in September 2019.
Its advantages are that no interest must be paid on the capital raised, so it is not necessary to invest profits in debt. Plus, the right investors can be crucial in providing expertise, advice, and even connections.
Its disadvantages are that, from the moment you decide to accept a single peso of this capital, your business ceases to be yours because you grant part of the ownership and decision-making power. You will have to consult your decisions with your investors and it may turn out that the investor does not add enough value to the business.
3. Financing with cash from clients: this type of financing was created by the expert in private equity John Mullins and has the objective that it is the clients who inject the capital into the company, either through subscriptions (recurring income) , ask for money in advance (reduce inventories and production investment), be an intermediary between customers and suppliers (reduce asset costs), and so on.
The advantages of this financing is that it allows you to validate your business model to find out if there are people willing to purchase your product or service; which at the same time gives you time to understand your market. Another advantage is that you can focus on growing and not paying off debt. It reduces the risk of the business since it can be financed with its own money, as have companies such as Dell, Rotoplás, Netflix, Zara, among others.
Before resorting to third-party money, it is important that business leaders have deep knowledge of their numbers and finances, then, from that, they look for the best option that allows them to reduce the risk of the company in the short, medium and long term. . This will be key in a year in which the most important issue will be cash.