Factors influencing finance options

Question 1

cost of the finance

Answer 1

This includes the repayments and interest. Eg, in times of high interest rates, loans can be an expensive source of finance whereas the reverse is true in times of low interest rates. Rates are very low at present, which makes it cheap to borrow.

Question 2

purpose for the finance

Answer 2

The source of finance must be matched with the use. For example, long term finance will be used for the purchase of fixed assets while short term will be used for short term purposes eg. purchases of stock

Question 3

control

Answer 3

If a firm issues shares to raise finance it will lose some control to the shareholders, whereas getting a loan will not involve any loss of control. If maintaining control is important then a company may get loan capital instead of issuing shares.

Question 4

security/collateral

Answer 4

If a firm gets a bank loan, security will have to be provided, but if it issues shares or uses retained earning no security is needed. Some firms may not like fixed assets tied up as security and will choose share capital instead of borrowing.

Question 5

type of business

Answer 5

Private limited companies (Ltd) and Public limited companies (Plc) find it easier to borrow than sole traders as they provide more detailed financial information. Sole traders often have to give personal guarantees to get finance.

Question 6

availability/ credit crunch

Answer 6

Banks are not lending as much as they were before the banking crisis. They are extremely cautious and pick and choose what firms to lend to. Many businesses simply cannot get overdrafts/loans from the banks. Strict conditions are attached to borrowings.

Question 7

gearing

Answer 7

Debt finance (borrowing) increases a company’s gearing while issuing shares or using retained earnings reduces the gearing. Most firms don’t like to be highly geared and try to keep borrowing at a reasonable level.