Where to Look for Funds

Companies raise money for expansion in three ways. First, businesses can use retained earnings, which is the money they earn through their operations and do not distribute as dividends to share¬holders. This simply means paying for an expansion project with the cash you generate through profits, similar to the everyday personal purchases you make. The second method is borrowing, and the third is equity financing (the selling of shares to investors).

Internal Financing
Your top source of capital is your company’s own cash. It comes from sales and shows up in profits. Yet, although internal sources are obvious, many financial planners overlook them when they are devising capital formation schemes.

Many internal financing schemes boil down to cash management. Plus, attention to cash management early in the financial planning process has value even if you can’t rely solely on internal sources. Effective cash management will help convince lenders and investors that you really know how to run a company and that you’ll treat their money with the respect it deserves. Capital formation begins with your company’s cash budgets. As explained, the real aim of cash management is to ensure you have the amount of cash you need just when you need it. There’s another advantage of careful cash management. Oftentimes, comparing actual cash flow with your predictions can signal an early warning of the need to improve management controls.
You can avoid costly mistakes by taking steps to head off a flow in the wrong direction before it becomes a flood. Some keys to improving your cash management:
● Keep your money in money market accounts. Not only will you earn interest, but you’ll be eligible for bank services, such as checking, at a reduced rate.
● Use electronic funds transfer instead of certified checks. Doing so will lower your bank costs and keep money working as long as possible.
● Offer discounts for customers who pay off their accounts early. This will reduce the costs you incur carrying receivables and will accelerate cash flow.
Carefully manage inventory, accounts receivable, accounts payable and surplus cash, and think of ways to increase sales. The next thing you know, you’ve got the capital to move to the next step in your growth plan. A penny-wise approach may give more obvious benefits to large companies with large amounts of pennies, but proportionally it will work for smaller companies as well.

Customers Come First

More companies are turning to their customers and vendors as potential sources of financing. New technologies have made so many businesses interdependent that the lines are often blurred as to where one company’s function ends and the other begins. According to Rick Canada, director of change management services at Motorola: “The best definition of a partnership . . . is when the buyer and the seller take on the characteristics of one organization, rather than two separate, distinct organizations.” When this occurs, it often forges a type of business marriage or partner¬ship in which two or more companies share the costs, risks and profits of a particular venture.

Make Your Employees Owners
Employee stock ownership plans (ESOPs) are employee trust funds to which an employer con¬tributes stock in the company at no cost to the employee. They are structured, however, so that tax advantages allow the company to borrow money at a nominal cost.

Until recently, ESOPs have been used primarily to shore up shaky companies. Usually, the troubled company turns over ownership rights (and risks) to employees in the hope of motivating the work force and securing “give-backs” on wages or benefits. Now, however, many successful companies are using ESOPs as funding vehicles because of their significant tax breaks.

Suppose, for instance, your firm wants to buy up part of its outstanding stock, but it doesn’t have the necessary cash on hand. First, the company creates an ESOP. Next, it borrows the money to buy the shares and places those shares in the ESOP. To repay the loan, the firm makes cash con¬tributions to the ESOP, and the ESOP pays the bank. In that way, both the principal and interest on the loan are fully tax deductible. As the loan is repaid, the ESOP stock is credited to accounts of employees participating in the plan.
ESOPs are not a one-shot deal. Year after year, a company can contribute what would normally be taxable profits to the ESOP, up to 25 percent of payroll. However, the contributions are made in stock—the company keeps the cash.
ESOPs can be valuable financing tools for midsize corporations, particularly closely held firms that might find it difficult to raise cash through normal channels.