Factors to Consider when Choosing a Source of Finance

There are many sources of finance available to a business. Finance is needed for several purposes and different purposes need sources of finance which are most suitable to them. When choosing an appropriate source of finance some factors have to be considered. The factors that need to be considered when choosing an appropriate source of finance are:
  1. The amount of money needed: This is the amount of finance the organisation wants to raise. Not all sources of finance provide all amounts of funds. Some sources are notable to raise large amounts of funds whereas others are not flexible enough to put up for the small sum of money the business requires. Therefore it is necessary to identify the amount of money needed by the company to choose a suitable source of finance. For example borrowing a commercial loan for a small and short-term cash-flow problem is unwise because loans may have a minimum amount that can be borrowed so taking a bank overdraft would be wise where money can be borrowed in small sums and bank overdrafts can be paid back quickly. Therefore the amount of money required is a key factor in choosing a source of finance.
  2. The urgency of funds: This refers to the amount of time the business can spend on collecting funds. If the business has plenty of time before its financial needs need to be met then it can spend time searching for cheap alternatives of sources of finance. On the other hand if the business wants the money as soon as possible then it would have to make some cost sacrifices and accept a source of finance that may even cost higher. The urgency of funds needs to be identified also because certain sources of finance need more time to be raised than other sources of finance. For example issuing shares is a very long and complex process where there are legal requirements and then the potential shareholders have to be informed (advertising) and after all these the money is collected through the process of application and allotment which takes more time.
  3. The cost of the source of finance: Different sources of finance have different costs. It is always more profitable to a business to seek and obtain cheaper sources of finance. Sometimes however the time does not permit organisations to look for cheaper sources of funds. Internal sources of finance are always cheaper than external sources of finance.
  4. The risk involved: The risk involved is the certainty of receiving returns for the lender on the investment made using the finance. In simpler words it is the sureness of success of the project. If the provider of finance is not confident that the project in which his money is invested in is less likely to reap returns then the lender would be reluctant to provide the business with funds. In this case the money can be secured against an asset as collateral which will encourage the lender to lend.
  5. The duration of finance: This is the time period for which the money is needed. It can be for a short-term (within one year), medium-term (one to five years) or long-term (five years and more) time period. By identifying the length of requirement of finance the organisation can eliminate inappropriate sources of finance and choose a source of finance that is more suitable for the required time frame.
  6. The gearing ratio of the business: The gearing ratio plays an important role in the availability of the sources of finance since the gearing ratio shows the ratio of debt capital to the total capital of a business. If a business is high geared then commercial lenders will be unwilling to give loans because the business is already operating on more loans than equity capital. A high geared company will have to pay more of its profits as interests on loans and other debt capital. That being the case potential lenders fears the business’ ability to be able to cope with more interest payments and debt settlement.
  7. The control of the business: The existing shareholders of a company would be reluctant to issue shares because this would cause a dilution in control of the business. Issuing shares in public limited companies also gives opportunity of takeovers to outside parties. The same can be said for venture capitalists where the money is invested as equity and being owners the venture capitalists have the right to influence how the business is run. The existing shareholders and owners of a business who would not want any change to arise in the control and ownership of the business would disregard sources of equity finance.

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