Selecting the Source of Finance

Size of the Business

Larger businesses usually have access to a wider range of finance sources, such as issuing shares or bonds, which are generally not available to smaller businesses.

Short-term vs. Long-term

For short-term needs, sources like overdrafts, trade credit, and working capital are more suitable.
For long-term investments or expansions, long-term loan, retained profits, or issuing shares would be more appropriate.

Risk Tolerance

Some forms of finance, such as loans and overdrafts, carry higher risks with them, including higher interest rates and strict repayment schedules.
Safer options like retained profits and grants carry fewer risks, but their availability depends on the business’s profitability or specific qualifications.

Interest Rates

Loans, overdrafts, leasing and hire purchase require interest payments, increasing the cost of finance.
The interest rate depends on the level of risk the lender perceives. A higher risk will lead to a higher rate.

Dividends

If a business raises finance by issuing shares, it will need to pay dividends to shareholders, which can be costly.
However, dividends are not obligatory if the company makes a loss.

Control and Ownership

Raising finance through issuing shares may lead to the dilution of control and ownership, as shareholders demand a say in company matters.
Loans and overdrafts do not affect ownership but can place restrictions on the activities of the business through covenants.

Legal Form and Size of Business

The legal form of the business can impact the availability of finance sources. Limited companies can issue shares to raise funds, while sole traders and partnerships cannot.
Smaller businesses may also find it harder to secure loans due to perceived risk.

Business’s Financial Status

A business’s financial status may affect its ability to obtain certain sources of finance. If a business is seen as a high risk of default, they may struggle to secure loans at favourable interest rates.

Business’s Industry or Sector

Some sectors may have access to special grants or government subsidies, making these a more available source of finance.

Existing level of Borrowing

Businesses need to look at their level of borrowing in relation to their equity capital. High levels of borrowing could lead to high costs and potentially higher risk.
On the other hand, a high level of retained earnings could signify to investors a lack of profitable investment opportunities.

Balance

Businesses must aim for a balance between borrowing and ownership capital, a concept known as optimal gearing.