Getting Personal
Tapping your personal assets is one way to fund business growth.

By Pam Newman

You can fund your business in a variety of ways. Business owners sometimes use personal funds, while other times they seek out investors and/or lenders. There are a number of ways to fund a business with personal finances, but you need to ensure that you understand the costs of using those funds versus getting outside financing.

One of the most popular ways of funding a business is through personal savings. Business owners have two main ways to account for money that they give to their business: record it as a loan to the business or show it as an equity investment. There are pros and cons to both, so consult with your accountant to ensure you are doing what is best for your particular situation.

Don't accept a "cookie cutter" approach for professional advice from your financial advisor. Work with someone who cares about your business and has time to look at the big picture of what is best for your business and you personally.

Personal Loans
Loaning money to your business will increase your cash asset and increase your liabilities. This loan to the business should be treated like any other loan. You need to ensure that you take time to document the loan to the business, including the amount loaned, date, terms for repayment, interest rate, etc.

When loan payments are made to you by the business, you should record the principal and interest payments accordingly. The principal amount reduces the loan liability and the interest amount is recorded as interest expense.

You should apply a fair interest rate when repaying the loan. Also ensure that you are documenting the receipt of payment and interest income for your personal records.

When adding debt to your balance sheet, you need to understand the effects that it has on your financial ratios. Outside lenders will analyze your debt ratio to see how much of your assets are financed through debt. While it is more favorable that the debt is to you personally versus a third party, it's still a liability of the business. Therefore, the business has increased obligations on the balance sheet by showing the funds as a loan.

To calculate your debt ratio, take your total amount of assets and divide it by your total amount of debt. For example, if your assets equaled 100 and your debt equaled 60, then 60 percent of your assets were financed by debt. The converse to that equation is the amount of your assets financed through equity (40 percent in the example).

Equity Investments
When contributing money to your business under the classification of an equity investment, you will be increasing your equity in the business (i.e., ownership value). When you take money out of the business for personal use, it is classified as an owner's withdrawal and is offset against your investments and retained earnings.

Retained earnings evolve from prior periods' earnings that are not paid out; therefore, the name "retained" in the business. When the time does come to raise money through outside sources, you will be in a stronger position (with less debt on hand) and look more desirable to external lenders and investors.

Drawing on Personal Assets
Most business owners have a number of personal assets they tap instead of outside investors or traditional business loans, including home equity loans, credit cards, retirement funds, whole life insurance policies and personal savings.

Through a home equity loan, you can take the amount of equity in your home and use it to fund your business. Often, the interest you pay on our home equity loan is tax deductible and the rates are lower than a traditional business loan.

Depending on the types of investment/retirement funds you have, you may be able to use those funds for business purposes. The most critical aspect you need to consider is the tax consequences for withdrawing funds prior to retirement age. Each plan has its own rules and regulations, so be sure to visit with your professional advisors (i.e., financial, tax, etc) to ensure that you understand the full picture and that these funds are truly the most beneficial way to bring cash into your business.

Credit cards are also an alternative for funding your business, although you must be cautious. Interest rates can quickly skyrocket and cause an unnecessary burden on you, both personally and professionally. Some credit cards offer short term, no interest options, and those can be good if they are used wisely and you ensure that you pay off the amounts prior to the interest kicking in.

Business start up and growth requires funds. The question business owners ask is where will those funds come from? Many business owners use personal assets to finance their business. There are a variety of options and what is right or wrong depends on your specific business needs and your personal situation. Seeking professional financial advice is the best place to start.

Pam Newman is the author of Out of the Red, a certified management accountant, Radio Host of "Unlocking the Secrets of Your Small Business", and a certified QuickBooks financial and point-of-sale ProAdvisor. For more information, contact her at (816) 304-4398 or www.rppc.net.