Every great business idea came to fruition with financing. In some cases, the business starts with very little: A 2006 “Forbes” article by Tom Taulli describes how two law grads from UCLA started LegalZoom from their condo with little capital, bartering legal services for IT help. As businesses get established, finance comes from other sources.
Debt and Liabilities
Companies finance operations by assuming liabilities, or debt. Financing through debt occurs when start-up costs are high and the owner knows few people who can provide capital. Thus, a restaurant business needing rent space, kitchen equipment and other high-cost items procure financing through a bank loan. The bank loan is a set amount of money with interest. Financing also comes from notes payables, or promises to pay in the future in exchange for using goods and services today. For example, a construction company needing a fleet of vehicles may get financing through an auto dealer. The business makes arrangements with the dealer to pay an incremental sum every month in exchange for use of the trucks. Families are also a source of finance, though the loans tend to be smaller than those from financial institutions: Simon C. Parker, author of “The Economics of Self-Employment” explains that some minority groups, such as Chinese and Koreans, rely on family financing more than bank financing.
Many businesses raise money by offering stock. Stock options are a source of finance that differs from a liability because of the repayment terms. Investors have the option to sell their stock at the market value, which could be higher or lower than the amount at the time of purchase. However, businesses have a duty to report to their shareholders how they conduct their operations. The ownership stake of investors depends on the type of stock purchased: investors of common stock receive one vote per share, whereas preferred stock holders typically carry no voting rights but get first dibs on equity if the company liquidates.
Sale of Goods and Services
As the business gets off the ground, financing of the business should come from the sale of its goods and services. Essentially, business operations should be the primary source of its revenue. If the business sustains itself through debt or other means, the company is not sustainable. To get the amount of money left over to finance operations, the cost to produce the item must be subtracted from the value of item’s sale. The amount left over once the cost is deduced from the revenue is profit, or money that can be reinvested into the business.
When companies make a profit, they may use this money to hire workers or upgrade their equipment. Another option that can be a source of finance is investing. Businesses invest its cash in bonds, mutual funds and other financial assets. Investing in these interest-yielding accounts usually provide a safe haven for cash while also generating additional money for the business.