Business finance, funding, overdrafts, working capital. Name it what you will, at some stage the…
How Do You Finance Your Business During a Cashflow Shortfall?
We all know that cashflow is the lifeblood of a business. As long as cashflow is positive and you have more money coming in than money going out, all is good.
But there are those times when the opposite is true and there’s more money going out than money coming in. This is called a cashflow shortfall. It is in these times, that as the owner of the business you put money into the business from your personal bank account. In some cases, you may even use your own personal credit card to pay the bills and in doing so you have effectively lent your money into your business.
Of course, you may be able to fund your cashflow shortfall by a bank overdraft or finance from the bank or other lending institution. Bank finance will have requirements on when you have to pay the money back, there will be interest charged for the duration of the loan and minimum monthly payments (unless the funding is a bank overdraft which won’t have any monthly repayment requirements).
The need to put your personal money into your business will happen in any one of three different circumstances:
- At start-up phase where you will need money to get the business up and running.
- During periods of significant growth. This will create a cashflow shortfall as inevitably you will be paying the higher costs before the higher income starts to flow in.
- During periods of business slowdown. This occurs when the income is insufficient to cover the bills and is usually a sign that the business is not breaking even and may in fact be making losses.
Consider then that you have two options for funding your cashflow shortfall.
- Borrow funds from a bank or similar. There will be interest to be paid as well as the principal amount borrowed will have to be repaid either at a set date or by monthly instalments over a set period of time.
- You put your own money into your business. In most cases, you don’t expect to pay back your money you put into your business for a long period of time and rarely do I see people charging interest on these loans.
I put it to you, that you need to consider your personal money that you put into your business the same was that the bank would treat a loan they might have lent you. You need to be charging a monthly interest amount that has to be paid and preferably you need to create a loan repayment plan with minimum monthly repayments over a pre-determined period of time to repay the loan in full back to your personal account.
In this way, you will think much harder about the funding of the business and at the same time don’t undervalue the funds lent to the business.
There is a different owner loan account. This is the one where you have drawn money out of the business more than you are entitled to draw.
This occurs at any time in the business cycle, usually but not always, when there is good positive cashflow and high profits. The owner will take surplus money from the business to spend on personal expenses/living costs etc. In doing this the owner has created a loan account where they have borrowed money from the business and thus they need to personally repay that money to the business at some time in the future.
The preference is not to create this type of loan account, but rather make sure that any money drawn from the business is either a repayment of a loan owing to the owners, or is a net wage, a dividend (if the business is a company), a distribution (if the business is a trust or partnership), or a drawing (if the business is a sole trader).
Fundamentally the key to personal loan accounts is to make sure that they are treated the same way that you would treat funds from a bank. In this way you will make sure that your business is viable and you’re not skewing the results and giving yourself a sense of comfort in the trading of the business which is just not true.
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