Business financing: What you need to consider

Sunday 12th November 2023

Business financing: What you need to consider

Sunday 12th November 2023
Written by Steve Roxby

Financing isn’t a dirty word. In fact, it’s often essential in business. 

According to recent data by the Australian Banking Association (ABA), 302,945 new loans were issued to small to medium enterprises (SMEs) in FY23. This equates to $588 billion in outstanding credit. 

But taking out business financing should never be taken lightly. It represents a financial commitment that can affect your business's stability and your personal wellbeing if you provide personal guarantees. 

So, what do you need to think about? Read on for our recommendations, including what to consider when your circumstances change. But first, let’s quickly go over some of the basics. 

What is business financing?

Business financing involves securing funding to support your operations, growth and investments.  Some common forms of business finance include bank business loans, private investment by venture capitalists shareholders, and asset finance.

Typically, business finance is split into two categories:

  • Debt finance – You borrow money and pay it back, usually with interest
  • Equity finance – Involves raising capital by selling ownership shares or equity 

There are also other types of business financing that fall outside of these two categories, such as small business grants. 

Why do businesses need finance?

There’s no one answer to why a business might need finance. Some of the common reasons business owners seek finance are:

  • To get start-up businesses off the ground
  • To explore a new product, service or market 
  • To hire more staff as the business scales up
  • To purchase new equipment, premises or another business
  • To help with seasonal trading
  • To cover cash flow problems 

Related: Why is cash flow important and how can I increase it?

Consider before you secure

Whatever your reasons for seeking business funding, in addition to deciding how much you want to borrow, here are some key questions we recommend you consider first.

  • What am I financing? – Will it be able to be used as security, e.g. property, plant and equipment, motor vehicles? Knowing what you’re financing can help you select the most cost-effective solution. Make sure your potential investment  aligns with your business goals
  • Does the term of the finance match the life of the asset? – For example, property could be up to 25 years, motor vehicle 5 years. If the asset's financing term is much shorter than the asset's expected lifespan, the generated income from the asset may not be enough to repay the loan before it matures. As a result, you might need to renew or extend the loan to manage the outstanding debt
  • What other security do I have to offer if required? – This is a key one to consider, especially if you’re seeking business debt for expansion or cash flow reasons. Different types of security you can use include residential property, commercial property and business assets 
  • Can I afford to repay the debt? Would a principal and interest or interest-only loan be more serviceable for you? Having enough cash flow to service any business financing you take out is crucial
  • What types of finance are available? – Here are some examples:
    • Property loan – P&I or interest only
    • Plant, equipment and motor vehicles – 
      • Chattel mortgage – The lender uses the vehicle, plant or equipment as security against the loan (you own it right away)
      • Leasing facilities – You borrow your plant, equipment or vehicles under a contract (less commitment and easy to upgrade)
    • Business working capital (cash flow) – Bank overdraft, P&I term loans, shareholders loans/investment
    • Business expansion (new business) – P&I term loans, shareholders, Investor loans, vendor finance
  • Is the structure tax effective? – The way you structure your business financing can have tax consequences. For example, loans and equity financing are treated differently for tax purposes. Debt interest payments are generally tax-deductible, while dividends on equity financing aren’t. If the entity borrowing the money is different from the entity using or investing the funds, it suggests there may be complex financial arrangements or transactions involved. Be cautious and understand the tax implications in such cases to ensure compliance with Australian tax laws. 
  • Is the asset protected? – What if something goes wrong? Can the bank sell it at their discretion? It’s important to keep your business and personal assets separate. Also, ensure you have adequate business insurance, such as public liability insurance, professional indemnity insurance, and asset insurance. 

Got finance, but circumstances changed?

Securing business finance isn’t typically a set-it-and-forget-it activity. Circumstances change for better and worse, so reviewing and assessing your financing is smart.

Here are three key things we suggest you look at in this situation:

Refinancing your business funding

Refinancing enables you to replace an existing loan or financial arrangement with a new one with more favourable terms. For example, you may be able to:

  • Increase the term of finance and reduce repayments
  • Switch to interest only instead of principal repayments
  • Get a better interest rate if rates have dropped
  • Secure finance from a new lender who doesn’t require as much security. Or restructure the security with your current lender

Boosting your cash flow

Cash flow is the lifeblood of your business’s financial wellbeing. If the flow is poor, you could be in trouble, so make sure you’re continually reviewing your projections—both profitability and cash flow. 

If you identify a future deficiency, take action now:

  • Discuss the situation with other stakeholders, including your financier
  • Assess other options for finance

Overdrafts are worthwhile, but if you’re always in overdraft, a P&I loan usually has lesser interest and can often smooth out your cash flow.

Related: Financial projections 101: profit and cash flow 

Assessing your security 

Reassessing the security of your business finance ensures that your financing arrangements remain in line with your evolving financial situation and business needs. Ask yourself:

  • As debt reduces and/or asset value increases, equity increases – Does my financier need all of the security they currently hold?
  • Can I use increased equity to borrow for other business initiatives?
  • Director guarantees are often required for business finance – Do I know what my exposure is?

The business financing essentials

Ultimately, when looking at business financing, such as a business loan, there are some key things you should be on top of and actions you should be taking.

Firstly, know your position. What do you owe? What is/was the financing for? Is it still relevant? What are your options? Can it be better structured? Can I get a better deal?

Secondly, know your cash flows. What are projections telling me? Am I going to have a deficiency? What about surplus: should I pay the debt off quicker? The answer to this really depends on your strategy.

In addition to this, consider your business strategy and/or personal goals. Ensure that your actions relating to finance are in line with longer-term plans. And speak to a business advisor for independent and professional advice. As an outsider, they can look at your situation from a different perspective.

Last but not least, talk to your financier about your business finance options, whether this means your bank, finance companies or a finance broker. 

Keen to optimise your business financing strategy? Reach out to your Maxim advisor or get in touch with our team.