Starting a Business: Personal vs. Business Spending
Starting a business, or turning a hobby into a business, comes with many challenges. Chief among them is managing (and access to) money.
Business Spending… is Investing
Before we touch on sources for money, we’ll touch on a very important paradigm shift when going from personal spending to business spending (investing).
When we buy something for ourselves we typically consider if we have the cash to either pay for it now or the cash to cover the payments. This paradigm has nothing to do with the future revenue, just what our current income will allow, and will we have enough left over for other purchases.
For business spending, while current revenue is important, the real consideration is regarding the increase in profitability that we expect from making the purchase. You are not spending money as much as you are making an investment; you expect a positive return. How much more money will you have in your pocket if you purchase a new machine or tool? In other words, is it a profitable investment?
When starting a business it is challenging to move away from the personal spending paradigm and adopt an investment mindset regarding purchases. Just because you have the cash to buy something does not make the purchase a wise one.
Deciding if you should make a purchase has to be made from the investment perspective. Think of the equipment cost as something that has to pay you back with interest over a defined period of time.
How will it do that?
There are two ways that new equipment can improve your profitability. 1) It can help you do something more efficiently, saving you time or money in other areas, or 2) it can let you create and sell something new that you currently cannot produce (or produce more of something). Understanding how you can be more profitable provides the basis for calculating your return on investment (ROI).
Regardless of how the equipment helps you, you need to be able to acquire it. To do this, you need to have the cash on hand or access to credit that allows you to pay for it over time. Either way, you still need to be disciplined in your ROI expectations. Again, just because you have the cash (or the credit) to cover the cost does not make it a good investment.
Sources of Money for Business
On the top of the list of challenges for starting a business is access to money, or capital. Capitalizing your business, putting in the money to start or grow it, can come from personal savings (yours, family, or friends) or business loans.
Using personal savings is one of the most common sources of money for a new business. It may be tempting to simply write checks from your personal account, but it is better to open an account specifically for the business and deposit your start up money there.
Among other benefits, this will make it easier to track expenditures and manage your monthly cash flow. We’ll have more tips on starting up the business in future posts, and a separate checking account will definitely be included.
Applying for a business loan can be intimidating, but it is well worth the time and effort. In addition to obtaining capital for the company, it is a great planning process for getting your business running or assessing growth plans. Most lending organizations will have people on staff specifically to help you through the process.
One of the benefits of the NPOs and SBA is the access to tools and coaches to help you with your business. As you explore the lending options, also consider broader relationships with the provider that can help you manage your new business.
These are credit lines opened for specific purchases. Typically, sellers will partner with credit companies to provide customers with credit terms for the value of their new equipment purchase less a down payment. These can be convenient, but you must pay attention to the terms of the credit agreement. While it is tempting to focus on the monthly payment, take a look at the APR and the total cost of the loan. Remember, this is (usually) an agreement between you and the credit company, not the seller of the equipment.
If you find yourself looking at multiple transactional credit lines but have not applied for a business loan, it would be worth talking to a local bank, SBA or NPO about a business loan or line of credit. These tend to be less expensive and the relationship you develop may give you more flexibility.
Credit cards are another, and perhaps most problematic, source of money for large ticket items. If the balance is not paid in the first billing cycle, interest is applied and usually at very high rates. Additionally, carrying the balance also means any additional charges for operating the business can start incurring high interest. In reality, many businesses resort to credit cards, but it should be avoided if possible.
Parting Thoughts on Business Spending
Whatever the source for your money, use an ROI calculation to determine when you expect to recover your investment and generate a return. Doing this is a reality check on the value of your expenditure and helps you stay focused on the business investment perspective.