Factors to Consider when Selecting Sources of Finance
- Time (duration)
According to the matching/moderate principle, assets and liabilities should be matched and the finance should be raised according to the maturity period of the assets to be acquired.
- Cost of finance
Different sources of finance attract different costs. The cost of financing will change according to the changes in interest rates.
- Borrowing capacity
This is the ability of the company to raise additional funds. It depends on existing borrowing and availability of assets pledged as security.
As a result of borrowing, the financial risk of a company will increase because of increased amount of debt in the capital structure.
- Availability of funds
Funds may not be available from all the sources of finance at the same time. Therefore the company may be forced to use available funds from the market.
The financing requirements of the company keep on changing overtime. The source of finance should be flexible enough to allow any changes that may exist.
- Size of the company
The borrowing capacity of the company will be determined by the industry where the company operates and the size of the company. Well established companies have a wide range of sources of finance compared to small companies.
- Terms and conditions
Lenders/creditors normally set strict terms and conditions in order to solve their agency problem with the shareholders. If the company does not comply with the terms and conditions it may not be able to get funds from the lenders in future.
Capital Structure of a Firm
This refers to long-term sources of finance employed by the company. The long term finance may include ordinary share capital, preference share capital and debt capital.