FACTORS AFFECTING THE SOURCE OF FINANCE

The choice of finance depends upon a number of factors further depending upon the time, purpose, the
type of organization etc. all these factors are to be considered before making a choice of source of
funds:

1. Cost: Both types of cost i.e the cost of procurement of funds and cost of utilizing the funds
should be taken into account while deciding about the source of funds
2. Financial strength and stability of operations: The Financial Strength i.e sound financial position
to repay the principal amount and interest on the borrowed amount is a major factor for this
choice. When the earnings of the organization are not stable, fixed charged funds like
preference shares and debentures should be carefully selected as these add to the financial
burden of the organization
3. Form of Organization and legal status: The form of business organization and status affects the
choice of a source for raising money e.g a partnership firm cannot raise money by issue of equity
shares
4. Purpose and time period: a short-term need can be met through borrowing funds at low rate of
interest through trade credit, commercial, paper etc. whereas for long term finance, sources
such as issue of shares and debentures are more appropriate. Similarly, a long-term business
expansion plan should not be financed by a bank overdraft which will be required to be repaid in
the short-term.
5. Risk Profile: Business should evaluate each of the sources of finance on the basis of risk involved.
E.g. there is a least risk in equity as compared to a loan that has a repayment schedule for both
the principal and the interest. The interest must be paid even if the borrowing company is
incurring a loss.
6. Control: Issue of Equity shares means risk dilution of the control as equity shareholders enjoy
voting rights. Thus, business firm should choose a source keeping in mind the extent to which
they are willing to share their control over business.
7. Effect on Credit Worthiness: The dependence of business on certain sources may affect its credit
worthiness in the market e.g. issue of shares of secured debentures may affect the interest of
unsecured creditors of the company and may adversely affect their willingness to extend further
loans as credit to the company.
8. Flexibility and ease: restrictive provisions, detailed investigation and documentation in case of
borrowings from banks and financial institutions may be the reason that a business organization
may not prefer it, if other options are readily available.
9. Tax Benefits: The dividend on preference shares is not tax deductible, interest paid on
debentures and loan is tax deductible and may, therefore, be preferred by organizations seeking
tax advantage.