The Best Choice of Finance (DP IB Business Management)
Revision Note
Written by: Lisa Eades
Reviewed by: Steve Vorster
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
Diagram: factors affecting the choice of finance
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
Diagram: short-term and long-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 having 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
Public limited companies are able to access a wide selection of sources of finance and are able to provide collateral as security for lenders
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
The cost 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
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
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
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
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