There are two ways to raise money for your business. Each have their own benefits. Click below to watch this quick video and learn more.
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Read below for the video transcription.
There are two ways to raise money, internally and externally. Over the long run, you must raise money internally. Which is through your sales and operations.
But think about Amazon. Think about Apple. Think about Microsoft. Think about Google. They all lost money in the beginning. That was external financing. I'll talk about that in a second, but here's my biggest "aha" when I opened my businesses.
The way I think as a business owner is far more simplistic than an accountant. Follow along with me. Think about a trough, money is going in and money is going out. You as a business owner, think about money coming in money, coming out. This was one of my bigger aha’s when I started running my own businesses. Okay. It seems obvious, your money comes in from product sales, raising debt, or getting equity. You put in the money or you get investors that simple. Three sources; sales, debt, and equity, that's it. There are no others.
It goes out for cost of goods sold, your variable costs, your overhead and your salaries, which I hope when you budget your salary is the number one salary on your list. You also may have to buy assets, equipment, building, something long-term you have to pay back the debt and maybe pay dividends to your investors.
Interest is an overhead. The repayment is over here. Now, if the money doesn't come in faster than it's going out, there's no money for you, which is why you're working harder for less money. Now just imagine this dotted line here, and this is why accounting is so confusing. Some of your cash coming in and cash going out is on the profit and loss.
Some of your cash coming in and cash going out is on your balance sheet and not just small businesses, but medium businesses and very large businesses are not paying attention to this side of the equation because they don't know how. No one showed you ever what to look at when to look at it, how to interpret it and what to do about it.
And that is a big fallacy with the accounting profession as a whole. Let me give you a more concrete example. Suppose you made $30,000, just assume. Now the first thing that you're going to have to do is pay taxes. Taxes don't even show up on your income statement or your balance sheet, unless you're a C Corp. If you're an S-corp Corp, a partnership or a sole proprietorship taxes are nowhere to be seen. That is a cash leakage. Now another one is receivables. Now let's assume you sell $600,000, but you don't collect $41,000. So you made $30,000 you got to pay taxes.
You don't collect some of your revenue. You are now approximately $23,000 in the hole, in terms of your bank account, your accountant's telling you made $30,000. $You're negative 23,000. Now let's make it even worse. You pay some of your debt. Let's say you pay $9,600 of your debt. You made $30,000, you're negative, approximately $33,000. That is a $63,000 swing between what you think you made and what's in your bank account, is everybody following that? Why there's a huge disconnect between what you're thinking as a business owner and what's going on. And frankly, this is as easy as it needs to be. To show you what's going on in your business. Cashflow and profit are not the same. These are coins. This is graphable. That's it.
First of all, you could borrow money or raise money through equity. Let's not deal with that, but your banker or somebody investing in you sees you differently. Those are the people who read your financial statements. They look at your reputation, your asset, your strength, but they do not evaluate you the way you evaluate you. Now, if you're borrowing money, they're looking at three things. One is your character, your commitment, your experience, your integrity. The second thing is your capacity to repay the money they give you. Whether it's short-term a banker or long-term an equity investor, they want to make sure they're going to get their money back. Unless they fall into three categories, friends, family, and fools. Other than that, they want to know how you're going to get paid back.
Third is your net worth. What is your company worth? What they're looking at is your net worth. What they're trying to figure out is how much pain can you take before you have to go bankrupt? Then they want to look at well, if I can't take the pain, how am I going to get paid back? And then they want to look at the economic and political environment, the social environment, and they're going to evaluate you.
But here's the key concept when you're raising money, don't ever ask for money unless you don't need it. So when I was starting my home building business, the first 10, 15 homes, we didn't have a track record. So I went to my banker and I said, here's what I have. I had a three ring new loose-leaf notebook. This is before the days of really using PowerPoint and computers and stuff like we have today. And in it I'd have a three to 10 page executive summary, my financials, my financial projections, copies of my blueprints, and other miscellaneous data. I wanted to pass what they call the weight test. The president came in, the, the owner of the bank, actually looked at our notebook, perceived to have our ducks in order and said to the Vice President of commercial lending. Give them whatever you want. It was that simple. The decision to lend you money is usually made within 30 seconds to one minute. The balance of the time is proving. You're worthy of the money.
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