Choosing the source

Every source of funds has its limitations, so no single source suits every need. A business usually uses a combination of sources. When choosing, it weighs these factors:

• Cost: both the cost of getting the funds and the cost of using them (interest or dividend).
• Financial strength and stability of the firm: a firm with steady earnings can take on more borrowing.
• Form of organisation and legal status: only companies can issue shares; a sole proprietorship or partnership must use other sources.
• Purpose and time period: the source should match the use of the money and how long it is needed.
• Risk profile: equity carries the least risk for the company, since there is no fixed payment; borrowing carries more.
• Control: how the source affects the owners' control over the business.
• Effect on credit worthiness: some sources may make lenders less willing to lend later.
• Flexibility and ease: some sources come with many conditions and restrictions.
• Tax benefits: for example, the interest paid on loans and debentures reduces taxable profit.

A simple test of good financing: long-term expansion should not be financed by a short-term overdraft, which the bank can ask back at short notice.