Choosing the most Appropriate Source of Finance
- Businesses need to investigate and select a combination of sources of finance that are most suitable for their particular needs
- Not all sources of finance are available to every business
- A poor credit history may exclude a business from applying for some types of loans or using an overdraft
- Business start ups are unlikely to be able to access sources of finance such as trade credit as may not have yet established a trading record and may be viewed as too risky
A range of factors will affect the most suitable sources of finance for a business
1. Timescale
-
- Short-term sources of finance will be needed to meet unexpected costs or to pay bills and suppliers
- These are likely to be relatively small amounts and are rarely needed beyond a year
- Longer-term sources of finance will be needed to fund the purchase of non-current assets such as buildings and other types of capital equipment
- These are likely to be large sums that may be required for a significant period of time
- These are likely to be large sums that may be required for a significant period of time
- Short-term sources of finance will be needed to meet unexpected costs or to pay bills and suppliers
Long-term and short-term sources of finance
2. Legal structure
-
- Sole traders, partnerships and small private limited companies usually have a more limited range of sources of finance as they are seen as a greater lending risk
- Interest rates on loans are likely to be higher as these businesses tend to lend smaller amounts than public limited companies and are not in a position to approach specialist lenders
- Interest rates on loans are likely to be higher as these businesses tend to lend smaller amounts than public limited companies and are not in a position to approach specialist lenders
- Public limited companies are able to access a wide selection of sources of finance and are able to provide collatoral as security for lenders
- Sole traders, partnerships and small private limited companies usually have a more limited range of sources of finance as they are seen as a greater lending risk
3. Cost
-
- Interest payable on loans can add a significant cost to the use of some sources of finance
- Variable interest rates change during the borrowing term which may make financial planning difficult
- Fixed interest rates remain constant for the period of the loan and for this reason they are usually higher than variable rates
- Costs of selling shares in public limited companies is an expensive process
- Flotation is usually carried out by merchant banks which charge a premium price for their specialist services
- Selling shares through a rights issue may reduce the amount of share capital raised as they are usually sold at a discount to existing shareholders
- Interest payable on loans can add a significant cost to the use of some sources of finance
4. Control
-
- Selling shares or raising venture capital can result in some loss of control for business owners
- Smaller businesses may have to accept the terms of more powerful suppliers or business angels as they have little power to negotiate
- Smaller businesses may have to accept the terms of more powerful suppliers or business angels as they have little power to negotiate
- Selling shares or raising venture capital can result in some loss of control for business owners
5. Purpose of the finance
-
- Certain sources of finance have particular uses
- A mortgage is the most appropriate type of lending to purchase land or property
- Overdrafts are flexible and are best used for short-term working capital requirements
- Certain sources of finance have particular uses
6. The level of existing debt
-
- Highly geared businesses already make use of significant amounts of debt
- Lenders and investors may be reluctant to provide further funds due to the level of risk the business presents
- Businesses with a poor or no borrowing history may not meet credit score requirements and would be excluded from most types of credit