How to Establish Business Credit?

With the rapid change in the financial world, everything related to finance is changing, whether it is credit facilities or investments. Steps are being taken to make everything simple, convenient, and fast. There is a consensus among financiers that businesses have different financial requirements, and there is a need to resolve them. One such step taken by these, which may help businesses, small or big, is to establish business credit. This is an option which you can avail of, where financial institutions provide loans, without needing the credit rating or the personal assets of the owner as security. And, most importantly, the organizations of every size and age can avail of it, whether it’s old or new, big or small. Whether you need finance for setting up or expanding the business, purchasing material or equipment, or advertising, this facility is always there for you.

Steps

There are various steps involved in establishing it. The first point that you should remember is to ensure strong fundamentals of your business. Moreover, you should also take care to see to it that you meet the requirements of financiers. Ensuring this would make listing of your business with commercial credit reporting agencies easier.

The next step is to develop a connection with suppliers and vendors. These suppliers and vendors should be such that they not just extend credit payments, but most importantly, report the history of your payments to the respective agencies. You need to have the backing of at least five such vendors, and they should not tie your personal guarantee or social security number while giving you such credit.

Obtaining credit cards for the same is the next step. You should get three such cards, but make sure that they are not connected to your personal credit. Moreover, you should also ensure that these credit card companies report your transactions and payment history to the concerned agencies. However, unluckily, there are not many types of such cards, which would consider approval without checking your personal credit report. In such a scenario, you should look around and search for such a card. Take your time in this step as it can be crucial. In case you are not able to pay your corporate bills on time, your personal credit would nosedive, even if you have an excellent history. Similarly, if your commercial credit history is excellent, but your personal one is not that good, it would affect your business ratings. So, it’s absolutely important to segregate both these entities. Once these steps are done, you can then opt to use these references so as to obtain bigger credits.

How to Establish It for the First Time?

Today, suppliers and creditors are increasingly checking, not only your personal, but also your commercial credit reports to decide on how much to lend and at what rate. This is the reason why it has become necessary to set up a separate report. In case you have set up your business for the first time and still haven’t established it, you can opt to get trade lines so that you can start building your respective report. You may incorporate or apply for a Limited Liability Company so that your business seems to be a separate entity. You can also get an Employer Identification Number from the Federal Government. Open up a bank account for it. Moreover, a dedicated phone line would do you a whole lot of good, but make sure that you list it. Once these steps are done, you can ask for business credit in the name of your company and start building a good score.

How to Establish It With Bad Personal Credit?

Even if you have a bad credit history, it is still possible to establish it. For this, you should legally separate from your business. If you don’t opt for this and you apply for one, your social security number would be used, and your bad personal credit would come in the way of getting you a good deal. For separating your personal finances from it, you need all the necessary licenses, and most importantly, apply for a tax ID number.

You need to start small as getting a business loan is easier for a startup without credit history, in case you have dropped your personal credit. Build it over time, paying off the amount you have borrowed on time and making the required payments on time.

You should not only concentrate on building the credit score of your business but also work on rebuilding your personal one, as well. Ultimately, you may need to approach a larger financier for a bigger loan, and in such cases, financial institutions consider both these scores.

Thus, the most important thing to remember, alike in all other cases, is that you should try to make your payments on time so that you can establish it fast. These are the necessary steps that will help you to build up a good credit score.

What is Tangible Net Worth?

One of the financial parameters which lenders care a lot about when deciding whether or not to finance a company is its tangible net worth. It represents the total of its tangible assets like land, building, machinery, inventory, etc.

Explanation

If there is any party which is most concerned with the tangible net worth, it is the lender. When a company approaches a lender and asks for a significant amount of money as a loan for expansion purposes, the lender will no doubt be a little wary.

The lender will view all the finances of the company, its performance, its ability to generate revenue and its ability to pay back the loan. Of the parameters it chooses to examine when they evaluate whether or not the company will pay back the loan, is the tangible net worth of the company.

One look at the word will tell you that it has got to do some thing with tangibility and the market value of the company. It is the amount of money that the company would realize, should it go into the market and sell all of its tangible assets. The distinction between tangible and intangible assets needs to be made here.

Tangible assets are those which can actually be touched, felt and sold. Intangible assets include goodwill, trademarks and patents which the company has. But, while intangible assets command a pretty good value, no one in the market will be willing to ‘buy’ goodwill, unless they buy the company outright. Therefore, tangible assets include all such items which have a resale value.

Importance

Let’s go back to the reference about the lender here. When a lender evaluates whether or not to give you a big loan, the lender no doubt wants to know if you will be able to pay it back. Should you default on the loan or become unable to pay the loan, the lender would like to have some sort of security against the loan.

And by calculating the worth of your tangible assets, the lender knows that in case of default, just how much you will be able to raise, should you sell your tangible assets. If the tangible net worth of the company is well above the amount of loan being given, and there are not many liabilities tied to the assets already, then the lender will have no qualms about giving the money to the company.

Calculations

Now from the above section, you understand that the two things associated with the tangible net worth is the tangible assets present with the company and the liabilities attached to them. Calculating it will also take into consideration the following factors.

Tangible Net Worth = Total Assets – Intangible Assets – Liabilities

As you can see, the tangible net worth is a pretty important consideration from the point of view of the lender, to be sure that the company has enough funds to pay back the money owed. This is what makes it such an important financial management variable.

Acid Test Ratio Formula

An acid test ratio, also known as quick ratio, is used to calculate whether the company will be able to meet its current liabilities with the short-term assets it has. Although working capital ratio is used for the same purpose, it includes inventories in short-term assets as well, which might not be easy to convert into cash. The acid test ratio formula, which does not include inventories is thus, a far more stricter test of determining a company’s current financial capability to meet its short-term liabilities.

Formula for Acid Test Ratio

In accounting, the acid test ratio formula is mathematically presented as follows:

Cash + Accounts Receivable + Short-term Investments/Current Liabilities

There is an alternative to this formula as well, which is:

Current Assets – Inventory/Current Liability

Example

To make it more clear, let’s take an example of a fictitious company ABC. In the balance sheet of ABC, the current assets are:

– Cash: USD 50,000
– Accounts receivable: USD 30,000
– Marketable securities: USD 5000
– Inventory: USD 30,000

Current liabilities are:

– Accounts payable: USD 20,000
– Accrued expenses: USD 15,000
– Notes payable: USD 3,000
– Long-term debt’s current portion: USD 7,000

Now, company ABC’s acid test ratio will be total current assets from which inventory is subtracted, divided by total current liabilities, i.e., (USD 50,000 + USD 30,000 + USD 5,000 + USD 30,000) – USD 30,000 / (USD 20,000 + USD 15,000 + USD 3,000 + USD 7,000) = 1.88

With the acid test ratio as 1.88, the company XYZ has USD 1.88 of short-term liquid assets to meet every USD 1 of current liabilities.

Interpretation

If the acid test ratio of an organization is less than one, it means that it does not have enough current assets to meet its current liabilities. That is why, it is very important for companies to maintain a high ratio, i.e., more than one. A ratio which is less than one or is decreasing, shows that the company is either paying bills very quickly or is collecting receivables very slowly or is unable to grow sales. A high ratio shows that the company has a fast conversion cycle and a good inventory turnover too.

Another thing that companies should consider is that in case the acid test ratio is very low, compared to the working capital ratio, it indicates that the share of inventory in current assets of the company is huge. Since inventory cannot be that easily converted to cash, the company has to be really cautious about its current financial position.

Acid test ratio formula, like most other financial ratio formulas of accounting, has its own drawbacks. Firstly, it gives no information about the cash flow timings and without this information, it is impossible to determine the ability of the company to pay liabilities. Secondly, it is based on the assumption that accounts receivable are available for collection, this however may not be true in reality for many companies. Thirdly, another assumption of the formula that a company would consume most of its current assets to pay for its current liabilities, is not possible in reality, as companies do need some working capital to carry on with its operations. Lastly, timing of the purchase of assets, payment policy, collection policy, allowance of bad debt, may vary from company to company so any comparison using acid test ratios of the liquidity of companies, might not be precise, unless and until the companies belong to the same industry.

How to Raise Money for a Business?

The capital is one of the first things that needs to be taken into consideration when one is setting out on a business venture, and there are many different sources to obtain this capital. It is not necessary to stick to one particular source rigidly; even a combination of various different sources can be used.

Anyone who is wondering how to raise money for a restaurant, a start-up, an advertising agency, or any other small-scale venture should keep these methods in mind. Approaching the right people for it is vitally important for the success of the business, and if this is not catered to properly, it will be doomed from the very beginning.

Personal Savings

This is the most obvious source of money for starting a business. If you have saved up enough money over the years, go ahead and make use of it to serve the underlying purpose. You will not be answerable to anyone, and you will not have to worry about repaying someone. If you choose this option, ensure that you are not using all your savings though. Many people neglect this option because if they lose it, they will have nothing left to live on.

Venture Capitalists

This is the next most obvious source for your initiative. Venture capitalists are professional agencies who put in venture capital into an upcoming business. What they get in return is either its share, or a share of the profits, or pretty high interest rates. It may sound like exploitation, but this is one of the best ways to get money. Venture capitalists are always looking for new and innovative business ideas that are likely to succeed.

Angel Investors

These are a refined form of venture capitalists, but many people think that they mean the same thing. Angel investors are less demanding than venture capitalists and remain with your initiative in the long run. Usually, these are someone who you would know personally, and they are simply looking for ways to get a higher return on their investment. How companies raise money depends a lot on the nature of the business and the method of entrepreneurship adopted. Angel investors also help them by providing some guidance and mentoring.

Personal Borrowings

Here is a method that should be avoided as far as possible. You can borrow money from someone you know, namely your friends, family, or other people. The problem here is that once you mix business and personal relationships, things start to get a bit sour. This is a situation that needs to be handled with great tact and diplomacy, and not everyone can manage to do that. Still, this is a method that many people consider.

Bank Loans

Another answer is to approach a bank for a small loan. With banks, you will not be required to pay a very high interest rate, but you will need sufficient documentation about the business model of your initiative. Along with that, your credit history and financial stability will also be scrutinized, in order to find if you are worthy of getting a loan. Most people would love to get it, but are simply not eligible. This is especially true for someone looking to collect the money, without owning any fixed assets.

Advertising

Here is another answer, but one that requires a suitable amount of investment and more than a fair share of patience. If you can handle the advertising of your upcoming company well, you can get more than enough money to sustain it in the long run. There are some websites that also allow you to advertise your business plan and then suit you up with a matching investor. This is a slightly unreliable method for sure, but it works wonders if one can find the right match.

Other Options

One can approach some small-business investment companies, business development commissions, life insurance companies, or a money broker. The reliability of these options will not be very high, and their demand may be exorbitant, but if you have run out of all other options, then this is something that you will need to resort to.

You should act as early as possible, in order to get sufficient capital and business financing. There is a variety of sources available, and as long as you have a great and reliable plan, you will be able to procure capital. It is not all that difficult; all you need more than anything else is faith in yourself.

What is the Difference Between a Public and Private Corporation

Companies are generally classified as proprietary firms, private companies, and public companies. While proprietary firms have a single proprietor who looks after the business, private firms can have some members who sit on the board and run it. Public corporations, on the other hand, are listed entities which have full-time board of directors consisting of a chairman, chief executive officers, managing directors, chief financial officers, independent directors, and audit professionals.

Private Corporations

A private company is held or controlled by the founders or promoters of the company. A privately held corporation can start its operations once it gets incorporated. It is not listed on the stock exchange and hence cannot raise funds through equities. One of the biggest advantage for a private company is that such a company does not have to show its financial information to the public. It is not answerable to shareholders like in the case of a public corporation.

In a private corporation, the management has total control over the company’s operations and it can take decisions in favor of the organization without much consultation with parties like major shareholders and stakeholders. So, the chances of an investment proposal getting rejected because of non-approval by sources related to the company are zero. Private companies are not allowed to offer their shares to the public unless they complete the formalities and listing process. Many people think that private companies are always very small as compared to public companies. However, this is not true as there are private companies that are earning millions of dollars in profits every financial year.

Public Corporations

A public corporation is a business entity which is listed on the stock exchanges of the United States. This is a company which has sold a part of its stake to the common public through an Initial Public Offering (IPO). So, it has many shareholders and it is mandatory for a public company to declare its source of funds, financial statements like balance sheets, its current debt, audited accounts, and information about its expansion plans to the shareholders and securities commission. The advantage that public corporations have over private corporations is that they can easily raise money to fund their expansion plans.

A public company has to give details about the salaries paid to top-level management. A public corporation can allot shares to its employees under employee stock options as per the designation/post of the employee. Apart from the senior management, a public company can have independent directors who give vital inputs for achieving fast growth. The shares allotted to the public can be of two types; ordinary shares and preference shares. The corporation has to pay a fixed dividend to preference shareholders and their money needs to be returned first in case of winding up of the corporation. However, preference shareholders do not have voting powers. Ordinary shareholders are the real risk bearers of a public corporation, and they are not entitled to fixed rate dividends. However, they enjoy voting powers in their company. Restrictions on transfer of shares are not applicable in case of a public company like in the case of a private company.

Public corporations have to take shareholder’s approval before making major investment decisions, mergers, and acquisitions or stake sale. In case the shareholders do not approve of the investment plan, the management may have to reject it. The level of business secrecy is absent in this type of organization as in private corporations.

Publicly listing a company on the exchange can help raise capital and when desired increase the returns for the shareholders. Apart from the IPO route, reverse merger process is adopted to make a company public, by acquiring a public shell company with zero assets and liabilities.

Importance of Social Cost Benefit Analysis

Social cost benefit analysis is a part of calculating the merits of a project or a government policy. As the name suggests, social cost-benefit analysis of anything is associated with its social impact. This means that how a project or a policy will affect people is analyzed. Only after calculating the opportunity cost of a project, it is approved.

The scope of social cost benefits can be applied to public investment and also to private investment. In case of public investment, it plays a major role in the economic development of a developing country. And, in case of private investments social cost benefit analysis is important as investments are to be sanctioned and are monitored by the government. There are two aspects of calculating the cost benefit analysis of any project. One is the private cost-benefit analysis and the other is social cost-benefit analysis. Though, social cost-benefit analysis is usually undertaken by the government.

Social cost is often in contrast with private cost. Major differences between social cost benefit analysis and private cost benefit analysis are as follows:

1. In social cost benefit analysis, not only profit but also other effects like how will it affect life of others are considered. Whereas, in private cost benefit analysis, the focus of the analysis is on maximizing profits.

2. For calculating social cost benefit, market prices for the factors to be considered cannot exist. Therefore, market price is not the main factor taken into consideration while calculating social cost benefit. Whereas, for private cost benefit analysis market price forms the base of the analysis and the key factor that determines if a project is viable.

Social Cost = Negative Impact
Social Benefit = Positive Impact

Social cost benefit analysis has been introduced to develop systematic ways of analyzing cost and benefits of factors which do not have market prices, like effect on environment and traffic. Social cost-benefit calculates non-monetized benefits/ losses. It is normally used for large fund projects like constructing a dam, a road. Such projects have higher social cost-benefits and also affects the price level to an extent.

Example: If a bridge is to be constructed then how much will it benefit the people who live in that particular area, is to be analyzed. Therefore, how many people are willing to use the bridge, how much traffic will be reduced and what is the increase in cost of traveling, will have to be assessed as a whole to come to a conclusion. Suppose, if people are not willing to use the bridge if the cost of traveling from the bridge is $5 and if $7 has to be charged per vehicle to make this project feasible, then the government may consider dropping the project out.

On the other hand, if people are willing to travel using the bridge, being indifferent to the toll price-difference of $2, and the traffic is reduced by a good amount, then the government will sanction the project. Therefore, it is beneficial to take up a project if its total benefits (B) are more than its total costs (C).

It can be put up as, a project should be undertaken if, B/C > 1 or even when B=C. That is, when the cost-benefit ratio exceeds unity or when benefit derived and the cost of the project is equal. Before sanctioning a project, cost and benefit of alternative projects are assessed too. For example, the opportunity cost of setting up a hospital instead of a school.

Importance of Social Cost Benefit Analysis

The importance has been explained with the help of the following factors that affect the general masses as a whole.

Market Failure
Market failure when a big project is not affecting everyone but only a few. A private firm would only look at profitability and related market prices to take up a deal but the government has to look at other factors. To determine the social cost in case of market failure and when market prices are unable to define them. These social costs are known as shadow prices.

Savings & Investment
Impact of the project on general savings and investment level. A project that induces more savings are investment in an economy and not the other way round.

Distribution & Redistribution of Income
The project should not lead to accumulating income in the hands of a few but, it should equally distribute the income.

Employment and Standard of Living
How a project affects employment and standard of living will be taken into account as well. The deal should lead to increase in employment and standard of living.

Externalities
Externalities are impacts of a project which can be both harmful and beneficial. Therefore, both the effects are to be assessed before sanctioning a deal. Positive-externalities could be in the form improvement in technology and negative-externalities could be in the form of increase in pollution and destruction of ecology.

Taxes and Subsidies
In a general cost benefit calculation, taxes and subsidies are considered as expenses and income respectively. Though in case of social-cost benefit analysis, taxes and subsidies are considered as transfer payments.

Social cost benefit analysis enables the government to take up new developments which will benefit everyone and not just a few. Also, it helps in bringing about an overall development in an economy and can help make decisions that will increase employment, investments, saving and consumption, thus, improving the economic activities in an economy.