Business Financial Terms
There are business financial terms, as a business owner, you are likely to encounter in the process of investigating funding options with lenders or potential investors. You will need to understand them so that you can make the best financial decision for your business.
Listed below are the most common business financing terms that you will likely encounter in your research for small business financing.
1 - Annual Percentage Rate (APR)
The annual percentage rate (APR) is the amount of interest on your total loan amount that you will pay annually (averaged over the full term of the loan). The total amount of interest to be paid is based on the principal (loan amount borrowed) and associated fees and is represented in percentage form. The APR is a good guideline to compare financial options since this represents the actual cost of borrowing for your business. The same term is also used with credit cards (personal or business), an alternative financial option.
2 - Appraisal
An appraisal is a market valuation of some type of property, such as a business, real estate or equipment, by the estimate of an authorized person. A financial lender will normally require an appraisal of your business value and assets as part of loan application process, particularly if you are applying for a secured business loan.
3 - Balloon Loan
A balloon loan is a type of business loan that does not fully amortize over its term. It is structured so that the business owner makes regular smaller payments against the loan on a predetermined schedule with one much larger payment at the end. Since it is not fully amortized, a balloon payment is required at the end of the term to repay the remaining principal balance of the loan. This type of loan can be attractive to a new business when it is limited in financial resources. However the new business needs to anticipate the last balloon payment that will be extremely large.
4 - Bankruptcy
Bankruptcy is a legal term for when a business or person cannot repay their outstanding debts. This legal process is normally initiated by the business (debtor) as a form of protection to provide a structured plan for reduction and repayments of debts to its creditors or to completely eliminate the majority of outstanding debts (due to not having the financial resources). This is an important, difficult decision to take since it has long term negative effects on a business credit history.
5 - Bootstrapping
In business terms, bootstrapping means financing the start-up and growth of a new a business using your personal income, savings and sweat equity. You, as the business owner, are your own principal investor. As the business grows, resources are stretched and reinvested, both financially and otherwise, to get it running successfully. It is not for everyone.
6 - Business Credit Report
Business Credit Reports are created by credit bureaus that record information about a business' financial history. They are used by lenders, investors and insurance companies to determine risk factors for issuing business financial loans. Business credit report bureaus include: Equifax, Dun & Bradstreet, and Experian. A business credit report will include information like how large the company is, how long has it been in business, amount and type of credit issued to the business, how credit has been managed, and any legal filings (i.e., bankruptcy) and a numerical ranking, similar to that of a consumer credit report.
7 - Business Credit Score
A business credit score (also referred to as a commercial credit score) is a numerical ranking based on the information found in the business credit report. The credit bureaus, using their own proprietary algorithm, take into account the information in the business profile to calculate this. A business credit score tells lenders how likely you are to repay them in a timely fashion. The higher the score the better the credit and the lower the likelihood (less risk) of a late or delinquent payment.
8 - Collateral
Collateral is any asset that is pledged as security by your business for repayment of a loan instrument. It is to be forfeited in the event of non-payment (default). Traditional financial lenders will often require collateral (a secured loan) to ensure that they will not lose money if your business defaults on payment. The financial lender has the legal right to seize the asset if your business does not meet the requirements of the loan.
10 - Debt Consolidation
It is a process by which a business takes out a single large business loan to combine several smaller loans. Normally the advantages for the business is a lower interest rate and possible better payment terms, including lowering your monthly payment amount. Often a business will use debt consolidation to help improve their cash flow.
11 - Debt-Service Coverage Ratio
The DSCR is the ratio of cash flow available to your business to pay current debt obligations. Your business debt payments include making principal and interest payments on the loan you are requesting. A financial Lender will typically calculate DSCR by dividing the business's annual net operating income by the business's annual debt payments. For example, if your business' net operating income is $125K and your annual debt payments are $100K, your business DSC$ is 1.25. In general, if your business DSCR ratio is above 1.0, your business has enough income to meet its debt requirements.
12 - Debt Financing
Debt financing means borrowing money and not giving up ownership of the business. Debt financing includes strict conditions or covenants in addition to having to pay interest and principal at specified dates to the financial lender. The borrowing can be via a loan from a bank, the use of business credit cards, lines of credit, third-party personal loans, merchant cash advance and invoice factoring. This is the most common way that a small business can raise capital.
13 - Equity Financing
Equity financing is the method of raising capital by selling company stock to investors. In return for the investment, the shareholders receive ownership interests in the company (and possibly voting rights). This differs from debt financing (above), where the business secures a loan from a financial lender.
14 - FICO Score
A FICO score is a type of personal credit score created by the Fair Isaac Corporation. It measures consumer credit risk. Financial lenders use a borrowers' FICO scores along with other details on the borrowers' credit reports to assess credit risk and determine whether to extend credit. If your business is considering debt financing, your personal FICO score will normally be included by the financial lender in the evaluation process since it is viewed as predictive of how responsible your business will be in repaying the extended loan.
15 - Financial Statements
Financial Statements are written reports that quantify the financial strength, performance and liquidity of a business. There are four main reports: the income statement, the balance sheet, the statement of cash flow, and the statement of shareholder’s equity, if your business has shareholders. Lenders and investors want to see that your business is well-balanced with assets and liabilities, has positive cash flow, and will have capital to make expected repayments.
16 - Fixed Interest Rate
The interest rate on a business loan that is established in the beginning and does not change during the term of the loan is said to be fixed. A fixed interest rate loan is desirable for a business owner (assuming the interest rate is competitive) since the repayment amounts are consistent and predictable for budgeting.
17 - Floating Interest Rate
18 - Guarantor
A guarantor is someone who “guarantees” your business loan or credit contract, that is, promises to repay the debt if the borrower can't or won't. A guarantor acts as a co-signer of sorts, in that they pledge their own assets or services if a situation arises in which the original debtor (your business) cannot perform its obligations. If you business is new, with limited financial history, a financial lender may insist that your business (as the borrower) has a guarantor for their loan.
19 - Interest Rate
Probably the most basic of business financing terms is the interest rate. All debt intruments, such as a business loan are assigned interest rates. This is the fee as a percentage of the principal amount charged by the financial lender for the use of its money. Interest rates are typically noted on an annual basis, commonly referred to as APR.
20 - Invoice Factoring or Financing
Invoice financing is a way for a business to borrow money against the amounts due from customers. A business contracts a factoring company to purchase the invoices at a discount. The business thus receives capital without incurring any debt, with the factoring company assuming the financial responsibility for collecting the invoice debt. Invoice financing helps a business improve cash flow, pay employees and suppliers, and reinvest in operations and growth earlier than if it had to wait until their customers paid their balances in full.
21 - Lien
A lien is a legal right granted by the owner of property to a third-party creditor. A lien serves to guarantee an underlying obligation, such as the repayment of a loan. If the underlying obligation is not satisfied, the creditor may be able to seize the asset that is the subject of the lien.
23 - Loan-to-Value (LTV)
A loan to value (LTV) ratio is a number that describes the size of a loan compared to the fair-market value of the asset used to secure the loan. Lenders and others use the ratio to understand how risky a loan is, and whether the value of the asset will cover the remainder of the loan amount if your business defaults and fails to pay the loan completely.
24 - Long-Term Debt
Long-term debt consists of loans and financial obligations lasting over one year. Long-term debt for a business would include any financing or leasing obligations that are to come due after a 12-month period.
25 - Merchant Cash Advance
A merchant cash advance is a financial instrument by alternative lenders structured as a lump-sum payment to a business in exchange for an agreed-upon percentage of future credit card and/or debit card sales. Repayment is normally made on a percentage of each card sales, allowing a business cash flow flexibility during their variable sales periods. The merchant cash advance is a short-term debt financing option.
26 - Microloan
A microloan is a loan for amounts under $50,000. Since most traditional banks do not offer business loans for this small amount, they are often provided by alternative vendors, non-profit and community-based organizations.
27 - Personal Guarantee
A personal guarantee is an unsecured written promise from a business owner guaranteeing payment on an equipment lease or loan in the event the business does not pay. Since it is unsecured, a personal guarantee is not tied to a specific asset.
28 - Principal
A financial loan instrument consists of three components: the principal, the interest, and the fees. The principal is the original amount that is borrowed or the outstanding balance to be repaid less interest. It is used to calculate the total interest and fees charged.
29 - Revolving Line of Credit
A revolving line of credit refers to a financial lender such as a bank offering a certain amount of always available credit to a business for an undetermined amount of time. The debt is repaid periodically and can be borrowed again once it is repaid.
30 - Secured Loan
A secured loan, is a loan in which the borrower pledges some asset (e.g., a equipment or real estate) as collateral for the loan (as a guarantee of payment). The asset being used as collateral for the loan is said to be “securing” the loan. In the event that your small business defaults on the loan, the financial lender can then claim the collateral and use its fair-market value to offset the unpaid balance.
31 - Term Loan
A term loan provide the business with a lump sum of cash up front in exchange for a promise to repay the principal and interest at specified intervals over a set period of time. These are typically longer term, one-time loans for start-up expenses or costs for established business expansion.
32 - Unsecured Loan
An unsecured business loan is a loan that is not backed by collateral (asset guarantee). These types of loans have higher interest rates and shorter repayment periods due to the higher risk for the financinal lender. Business credit cards is an example of an unsecured loan that a small business owner may use with other financing options.
Reserved for future terms.